Reply #26: The Specter of Stagflation

[Ghost Dog]

"Stagflation" is back in the headlines—but the term is being misused, and that's an important story. We're told by eminent newspapers and commentators that stagflation is the messy mixture of both high inflation and high unemployment. It isn't. Stagflation, at least as the concept was initially understood in the 1970s, meant something different. Yes, it signified the simultaneous occurrence of high inflation, high unemployment and slow economic growth; but its defining feature was the persistence of this poisonous combination over long periods of time. Although we're drifting in that direction, we're not there yet.

Let's see why this is a distinction with a difference. The coexistence of high (or rising) inflation with high (or rising) unemployment is not an abnormal event. But it's usually temporary, because the higher unemployment—stemming from an economic slowdown or recession—helps control inflation. Companies can't pass along price increases; they're stingier with wage increases. It's only when this restraining process is not allowed to work that inflationary psychology and practices take root, creating a self-fulfilling wage-price spiral. Higher wages push up prices, which then push up wages. Then we get stagflation: a semipermanent fusion of high joblessness and inflation.

Naturally, no leading politician is willing to acknowledge the self-evident implication: that recessions, though unwanted and hurtful to many, are not just inevitable; sometimes they're also necessary to prevent the larger and longer-lasting harm that would result from resurgent inflation. Interestingly, many economists (even those in academia and private industry who, presumably, have more freedom to speak their minds) suffer the same deficiency. They treat every potential recession as a policy failure when it is often simply part of the business cycle. They thus contribute to a political and intellectual climate that, focused on avoiding or minimizing any recession, may have the perverse result of aggravating inflation and leading to much harsher recessions later. The stagflation that began in the late 1960s and resulted from this attitude was indeed dreadful: from 1969 to 1982, inflation averaged 7.5 percent annually and unemployment 6.4 percent.

/... http://www.newsweek.com/id/114803?from=rss