Could Stagflation Reappear in the US?

U.S. media speculation is growing about the possible re-emergence of a ghost from the economic past: high inflation coupled with high unemployment. Stagflation crippled the economy in the 1970s and early 1980s, as surging oil prices, growing unemployment and easy monetary policy caused inflation to hit 14.8 percent in 1980.

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A return of stagflation would mean a financial nightmare for markets, retirement plans, policy officials, politicians and ordinary Americans. Steve Weiss, the chief investment officer of Short Hills Capital Partners, recently told CNBC that "stagflation is partially here."

At a press briefing ahead of a Group of Seven (G7) meeting in Germany, U.S. Treasury Secretary Janet Yellen said that "higher food and energy prices are having stagflationary effects, namely depressing output and spending and raising inflation all around the world. These pressures are not likely to abate in the very near future."

That statement was followed by a rare admission of error by the treasury secretary, who admitted to being wrong about the seriousness of the current inflation - the highest in 40 years. Last week, Yellen said she had been in error when she had anticipated inflation would be a small risk. Such an admission is viewed by critics as extremely rare in this embattled administration.

Former Federal Reserve Chairman Ben Bernanke said current Fed leaders acted too slowly to curb inflation, adding that this could spark a period of stagflation. That statement was a rare criticism from a former Fed official against the central bank's current leaders.

In an interview with the New York Times, Bernanke said inflation is "still too high but coming down. So there should be a period in the next year or two where growth is low, unemployment is at least up a little bit and inflation is still high. So you could call that stagflation."

Bridgewater Associates, the world's largest hedge fund, is also concerned about a possible return of stagflation. The firm's co-Chief Investment Officer Bob Prince recently told Bloomberg TV that markets have not fully absorbed the shock of what's occurring in the economy. When asked whether the economy will see stagflation, Prince answered, "We're on the cusp of it, yeah."

Experts, business leaders and economists said inflation is due in large part to major injections of COVID-19 stimulus. Also to blame are ongoing supply chain bottlenecks. Still, many economists do not believe the United States will see a re-run of the stagflation that crippled the U.S. economy in the 1970s.

Desmond Lachman, a former official at the International Monetary Fund (IMF), said it seems very unlikely that the country will return to a prolonged period of stagflation like in the 1970s. But with the Fed's shift to 50 basis point interest rate hikes and the withdrawal of market liquidity starting a period of quantitative tightening, it is more likely the country will see continued weakness in the equity and credit markets.

That will lead to an economic recession by early next year. If that occurs, the U.S. will see a fairly quick decline in inflation but a significant decline in output and employment, Lachman predicted.