Setting the Stage for Stagflation; Unemployment and Inflation Rise Together

The Washington Times (Washington, DC), February 19, 2010 | Go to article overview

Setting the Stage for Stagflation; Unemployment and Inflation Rise Together


Byline: Robert P. Murphy , SPECIAL TO THE WASHINGTON TIMES

Prices rose 2.7 percent during 2009, according to the Bureau of Labor Statistics' recent update of the Consumer Price Index (CPI). This is a worrisome fact because last year's unemployment rate averaged more than 9 percent. This trend may signal a return of stagflation, a merger of stagnation and inflation.

In the 1970s, stagflation shocked traditional Keynesian economists, whose models said the economy could not suffer from both high unemployment and rapid inflation at the same time. Unfortunately, the Keynesians were wrong, because an economy obviously can experience both evils simultaneously.

Ever since the worldwide financial panic started in September 2008, the financial press has drummed into Americans' heads the notion that we are poised on the edge of a deflationary cliff, just as in the early 1930s. It was fear of a falling price spiral that spurred the Federal Reserve into making extraordinary interventions, such as a near tripling of the Fed's balance sheet and the cutting of short-term interest rates to virtually zero. Under normal circumstances, such easy Fed policies would be very dangerous, but the experts continually assure the public that high unemployment denotes slack in the economy and thus no danger of price inflation.

Throughout most of 2009, the financial press would report that the year over year change in the CPI was negative. Although technically true, such statistics were misleading. What really happened was that prices fell very sharply in the final months of 2008, giving the backward 12-month comparison the appearance of deflation. Now that this one-year window has moved past the sharp drop of late 2008, the standard measures show inflation is back.

To underscore that the U.S. economy has not been in deflation for some time, consider this: In the past decade, there were five years in which prices rose less than they did just last year. Does that sound as if the U.S. is still balanced on the edge of a deflationary cliff?

The typical view is that an economy in a deep recession is in no danger of price inflation. This belief is wrong both in theory and in practice. The classic explanation of price inflation is too much money chasing too few goods. …

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