Slaying Inflation & Stagflation

Stagflation. An economic condition not experienced since the 1970’s – which was also the last time that inflation was as high as it is today.

Stagflation is an understandable word: stagnated growth coupled with persistent, high inflation. Often high unemployment is also part of the picture but presently is not the case. The reason stagflation is currently in the conversation is that in addition to current high levels of inflation, there are potential factors that could weigh even further on the US economy: tax increases and greater government spending. Stagflation could result – or could be inevitable no matter what.

Higher interest rates and focused policy today could be a small price to pay for a more balanced future with modest growth and less inflation.

The silver lining that could allow the US economy to avoid stagflation is continued strong consumer demand following the pandemic. Most signs point to consumer demand and spending returning, but with understandable rough patches here and there.

For these reasons, an observant panel at The Wall Street Journal* recently encouraged the US Fed to persevere in “slaying the stagflation dragon now”* instead of adding tax increases, large government spending and regulation. The idea is to remain laser-focused on lowering inflation, first and foremost, even if one of the most effective ways to lower inflation is the US Fed raising interest rates.

With rising interest rates could come a handful of short-term, unpleasant side effects that in the long run could lead to a more balanced economy.

The short-term could mean (as we are already seeing) –

  • lower stock prices – higher interest rates mean that fixed rate corporate and government bonds and cash instruments can look slightly more attractive than a portfolio of near 100% stocks.
  • a slowing housing market – we are not seeing a slowing yet, but higher mortgage rates could slow the growth of home prices in certain markets.

The longer-term could mean (with no certainty) –

  • an eventual (over the next 1-2-3 years from today?) gradual recovery in stock prices
  • slightly more reasonable home prices – does anyone really believe that home prices can go up forever? History is strewn with cyclical up’s and down’s in home prices.
  • a moderation in government spending and debt.

Stagflation is an economic condition the US has been able to avoid for decades despite the financial and economic devastation that occurred during and following the 2008-2009 financial crisis. Higher interest rates and focused policy today could be a small price to pay for a more balanced future with modest growth and less inflation.

*, The Editorial Board, April 28, 2022.

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