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Economy in Brief

Got Recession? Stagflation? Inflation?
by Robert Brusca  June 9, 2022

For the pessimists, the race is on. Who can project the gloomiest scenario? The OECD sees growth slowing. The World Bank has just released a report in which growth slows and inflation is stubborn and -gasp- is stagflation back? Ray Dalio of Bridgewater is making waves with a forecast that the Fed will have to cut rates again in 2024! Really?

That forecast is being 'sold' as something controversial. But if central banks are hiking rates in 2022 as many are, it would not be surprising that they would be cutting them in 2024- would it? How long do tightening cycles last anyway? I really don't see the controversy, but part of the talent of being widely quoted is selling a new sizzle on an old steak.

Apart from marketing, however, we have some news about monetary policy that should give you pause. And the drumbeat of talk about stagflation cannot be dismissed.

Stagflation refers to a period in which inflation remains high as growth weakens (stagnation + inflation = stagflation). We experience some 'stagflation' in just about every recession as growth falls and inflation remains high. The difference is that recession tends to 'cure' inflation and then recessions end and growth resumes. The sobriquet 'stagflation' is meant to describe a longer-lasting period of 'too-high inflation' coupled with 'too-low growth.' So, the question is whether that is on offer or not. Is it?

Has stagflation become the unofficial policy goal?
It may be. The evidence is that neither the ECB…which still has not moved – and by that, I mean ECB policy has not moved. It has not moved any more that the ECB building itself in Frankfurt has moved...although given the constant (small) drift of the earth's tectonic plates, the ECB's building may have moved more that ECB policy over the last year or so as inflation has roared.

In the U.S., the Fed denied inflation, prevaricated, called inflation 'transitory' and finally admitted it was here and that it was excessive, but it still set out a long runway for tapering that kept interest rate policy unchanged for months while inflation continued to mount.

Oh, we have lip service from central bankers. They abhor inflation like nature abhors a vacuum. But so far, they have been willing to do very little to move or to pledge policy to contain it. Interestingly, markets portray the Fed's actions and talk as tough. But let me take you back to the 'thrilling days of yesteryear….' Imagine Paul Volcker heads the Fed (hypothetically – I mean). And, as Fed Chair, he pronounces his desire to quash what has been rampant inflation by moving the Fed funds rate to…neutral. Neutral?

Yes. The Fed has set its goal on a neutral (long-term neutral at that) fed funds rate. Markets are agog (probably a-Twitter, too) over the Fed's 'aggressive' stance. But neither the Fed nor the ECB are being what would be considered aggressive according to any reasonable historic benchmark. They are both well-behind the curve. So, what is going on, or better put, why is this going on?

The same sorts of tectonic policy shifts are in progress in both the U.S. and Europe. In Europe, the Germans and other hard money advocates made the ECB in the image and likeness of the Bundesbank with all the safeguards they could imagine. Then they proceeded to implement a tight-fisted Germanic policy over Europe including the enforcement of painful budget rules on fellow EU members. This austerity may have had a constituency in Germany, Austria, the Netherlands, and a few other places, but it was not the preferred policy for most in Europe. Greece, Spain, Ireland, Italy, and Portugal were caught in painful fiscal traps. Not surprisingly, down the road, the rest of the monetary union rebelled and although the ECB has only an inflation mandate it now has an average rate target- no longer a ceiling rate. And with an unspecified average as the target, the ECB can do almost anything. The ECB has made its separation from the Bundesbank complete- we have lift off.

In the U.S., former Fed Chair Janet Yellen, now U.S. Treasury Secretary, has warned that inflation will be hard to contain and has sided with a World Bank forecast that sees world growth slumping to 2.9% in 2022 from what was 5.7% in 2021 – the Bank previously had looked for 4.1% growth in 2022. Meanwhile, inflation is expected to remain elevated, and the Russia-Ukraine war is a major culprit in this slow and painful adjustment process.

Janet Yellen's concerns about stubborn inflation are joined by earlier comments from former Federal Reserve Governor and Vice-chair Alan Blinder who wrote an Op-Ed warning to not expect miracles from Fed policy. Miracles? How about results?

Line up all these comments and you find weakening growth and warnings for stubborn global inflation and a Federal Reserve that might not find it 'easy' to achieve its 2% target.

But why? I thought that the 'zero bound' was 'the problem' and that central bankers 'knew' how to control inflation...silly me!

The real point here is that concerns of growth and of rising unemployment have risen. Several decades of low inflation have caused central bankers to assume that low inflation is the way of the world, and that central bank policy needn't be vigilant (or as vigilant) anymore. In the U.S., the Fed already has changed its operating statement to make full employment its primary goal pledging to use 'all its tools' to create full employment; it is silent on inflation other than to admit it targets an average of 2% that can and should be 'overshot' from time to time without penalty.

Paul Volcker is dead
Paul Volcker is dead- both literally and figuratively. There is no will to fight inflation as Paul once did. There is a new belief that inflation is not the risk as it was through the entire Post War period until Volcker helped to corral it. So, this is where stagflation comes from. When central bankers are unwilling to pay the price to stop inflation, inflation does not crawl back into the tube on its own and die. It remains too high; it adversely affects growth. When central bankers avoid creating recessions; they take too long (maybe never?) to achieve price stability; growth suffers, and inflation lingers. In short, Stagflation is what central bankers' policy objective have become. They are targeting stagflation. So, there is a good chance that we will get it.

Commentaries are the opinions of the author and do not reflect the views of Haver Analytics.
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