Despite Fed Assurances, Stagflation Fears Grow
RENEE MONTAGNE, host:
In more unpleasant news about the economy, a closely watched survey shows that manufacturing is contracting, but prices are going up. This combination of a slowdown and inflation is sparking worries about a nasty malady called stagflation. We called David Wessel to talk about this. He's economics editor of The Wall Street Journal.
Mr. DAVID WESSEL (Economic editor, Wall Street Journal): Good morning.
MONTAGNE: Now, stagflation is one of those words that sound, in a way, like what they mean.
Mr. WESSEL: Stag for stagnation, flation for inflation. It's a term actually that goes back to Great Britain in the 1960s, but it was last applied in the U.S. in the 1970s, early '80s when inflation rose very high, to nearly 15 percent. We had three recessions in a decade, and unemployment peaked at 9 percent.
There's this feeling of rising unemployment and rising inflation at the same time has a lot of people talking about stagflation. I looked in the Factiva database and I found 1,856 references to stagflation so far this year. That's as many all 12 months of last year.
MONTAGNE: Well, compared to the 1970s, how bad is unemployment now and how high is inflation?
Mr. WESSEL: Oh, that's a great question. We are nowhere near the 1970s. The consumer price index is running at about 4.3 percent above last year. The unemployment rate is now below 5 percent. But the Fed's favorite inflation gauge is rising than at any time since 1991. And people are worried that all this food and energy prices are spilling over into the rest of the economy and inflation's getting worse at exactly the same moment that we seem to be about to suffer an increase in unemployment.
MONTAGNE: So why is stagflation so worrying?
Mr. WESSEL: Stagflation is sort of like having two viruses at the same time. It would mean that for a lot of people, wages wouldn't go up, but at the same time, the cost of living would be rising. So it's really the ultimate squeeze on the working American.
But if you're at the Federal Reserve, you basically have one lever. You can cut interest rates to try and get the economy to grow faster and bring down unemployment, or we can raise interest rates, and that helps slow the economy and bring down the inflation rate. The problem is you can't pull the lever both ways at the same time.
In the early 1980s, Paul Volker, then chairman of the Federal Reserve, chose to fight inflation. He raised interest rates and put the economy through a wrenching recession. Ben Bernanke, the current chairman, is choosing to focus right now on fighting the stag and says he'll worry about the -flation later.
MONTAGNE: So what does it look like will happen?
Mr. WESSEL: What the Fed is hoping is that it can lower interest rates now and get the economy going, avoid a deep recession. It hopes that slower growth, though, will mean a lot of slack in the economy, and that will bring down prices. Because when there's more unemployment and less demand, prices tend to come down. And it's hoping that this recent spike in energy and food prices won't spill over to the price of everything else we buy so that inflationary pressures will gradually abate.
The most important thing to the Federal Reserve is that everybody believes that inflation is going to calm down and not get worse. They call this inflation expectations. It's kind of the Tinker Bell school of monetary policy. If everybody believes that we won't have inflation, they won't demand raises. They won't raise prices. And the Fed is watching very carefully these surveys that show what the public and business thinks of inflation, hoping to keep those under control.
MONTAGNE: David Wessel is economics editor of The Wall Street Journal and a frequent guest on our program.
Thanks for joining us.
Mr. WESSEL: You're welcome.
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