The New Stagflation

The Wall Street Journal reported on Saturday (October 1, 2011, p. A10) that consumer prices in Europe rose 3% over the past year, the fastest pace in three years. During the same time, prices in America rose 3.8% (measured by the CPI-U, without seasonal adjustment). In both Europe and America, the economies are stagnating, either barely growing or maybe nosing downward. Unemployment remains high, especially in America. Consumer confidence is flagging. Governments are dysfunctional. Markets look askance upon banks rumored to be facing EU sovereign debt exposure. Credit default swap dealers prosper.

The atmosphere is reminiscent of the stagflation of the 1970s, with its unrelenting malaise, lousy stock market, and embarrassing leisure suits (indeed, leisure suits have made a minor re-appearance recently). Some argue that today's conditions are far removed from the stagflation of yore, comparing the 13% inflation of 1979 to today's 3.8%. But that's not all the pertinent information.

Disposable income is stagnant, and even dropped 0.1% in August after adjustment for inflation. In other words, we're losing ground. Back in the 1970s, nominal incomes largely, but not entirely, kept pace with inflation. The net result was similar to current times: people gradually lost ground. The economy grew very slowly in the 1970s, around 1% a year, and unemployment levels, although not as bad as today, were high compared to the boom years of the 1950s and 1960s. Like the past decade, the 1970s experienced a falling stock market.

When you get to the bottom line, history is rhyming pretty well even though it's not a carbon copy of the disco era. This puts policy makers, especially central banks, in a tight spot. If they raise interest rates to tamp down inflation, they increase the potential for recession. If they ease monetary policy, they facilitate inflation. The European Central Bank is keenly aware of this dilemma, contending with fear of inflation in northern Europe and high unemployment in less vigorous parts of the EU. Its governing council meets next week, with no good options to consider.

The U.S. Federal Reserve, now a house divided, remains controlled by governors who view unemployment as a greater problem than inflation. Consumers should expect no relief from the Fed. While the Fed continues to insist that inflation poses no long term problem, that offers little comfort to those trying to pay this month's rent, as well as the grocery and gas bills. Nor is there much reason to believe that more intervention by the Fed will greatly affect employment levels. While the Fed acts like its mojo is working, reality is we're drifting in a new stagflation.