What is stagflation?: Why economists fear a 1970s-style catastrophe

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Soaring consumer prices, supply chain shocks, rising energy costs, and a tightening Federal Reserve determined to get inflation under control: these are the worrying features of the US economy that have caused some pundits to sound the alarm if it a possible return to 1970s-style ‘stagflation’. “

Stagnation is the combination of economic stagnation and high inflation, characterized by rising consumer prices and high unemployment.

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The phenomenon devastated the US economy in the 1970s and early 1980s, as rising oil prices, soaring unemployment and loose monetary policy drove the consumer price index as high as 14.8% in 1980 and forced Fed policymakers to raise interest rates to almost 100% that year 20% increase.

People buy groceries at a supermarket in Glendale, California January 12, 2022. (ROBYN BECK/AFP via Getty Images/AP Newsroom)

A telltale sign and consequence of stagflation is rising energy prices, according to many economists, who believe it occurs when a sudden increase in oil prices reduces an economy’s productive capacity. For example, in 1973 the Organization of Petroleum Exporting Countries imposed an embargo on oil supplies to the United States because of its support for Israel.

The onset of the embargo exacerbated an upward spiral in oil prices, with the price per barrel doubling and then quadrupling. Soaring oil prices have resulted in sky-high costs for consumers, who have been forced to contend with long lines at gas stations and rationing measures such as food “odd-even” purchases by license seat number.

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It came as a major shock to an economy that had become dependent on cheap foreign oil.

Although the crisis seemed to fade with the lifting of the oil embargo in 1974, the relief was temporary: the Iranian revolution brought a second wave of dramatically high prices in 1978-1979.

Some economists believe the US economy is showing signs of “stagflation” today as the Russian invasion of Ukraine has sent oil prices skyrocketing. Americans have already grappled with the hottest inflation in 40 years, prompting the Federal Reserve to aggressively tighten monetary policy with a series of expected rate hikes.

Larry Summers, President Emeritus of Harvard University, speaks during a discussion on “A Reform Agenda for Europe’s Leaders” at the World Bank-IMF annual meeting in Washington October 9, 2014. (REUTERS/Joshua Roberts/Reuters photos)

Former Treasury Secretary Larry Summers, a prominent inflation hawk, has accused the Fed of misreading the rise in inflation and waiting too long to take action to quell the rise in prices. In doing so, Summers wrote in a recent Washington Post op-ed, the central bank has paved the way for “stagflation.”

“I believe the Fed has failed to internalize the extent of its mistakes over the past year, is operating within an inadequate and dangerous framework, and needs to take far more action to support price stability than seems likely,” Summers wrote. “The current Fed policy stance is likely to result in stagflation, with average unemployment and inflation each exceeding 5 percent over the next few years — and ultimately a major recession.”

In his opinion, Summers is not alone.

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Danielle DiMartino Booth, CEO and chief strategist at Quill Intelligence and a former adviser to a Dallas Fed president, said that stagflation “appears to be an upcoming development.” She cited dwindling economic growth forecasts for the first quarter, as well as energy and food inflation twice as high as in the 1970s.

“Instead of having an opportunity to ease monetary policy in a slowing economy, the Fed is launching a tightening campaign,” she said.

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