Stag-Baby

Yesterday, the Fed released its beige book, a summary of economic activity prepared for use at the central bank's Federal Open Market Committee meeting set for March 18. The report suggested that the US economy is slowing in growth amid upward price pressures. The Beige Book only confirmed what many are worried about: STAGFLATION.

Stagflation is so emblematic of the seventies that I feel like we should don some groovy “Whip Inflation Now” pins on our cowl-neck sweaters as we discuss it. Stagflation has become the newest worry to plague the investment landscape, so its time to parse the word and understand whether we need to really become alarmed about the prospects of stagflation today.

“Stagflation” describes the condition of slow economic growth (usually highlighted by relatively high unemployment) - a time of stagnation - accompanied by a rise in prices, or inflation. You may think, “Well, we have the slow growth part and the rising price part, so we must be staring down a pretty nasty barrel.” Before getting too crazy about the situation, it is important to note that today’s “stagflation” while serious, is far different than the 1970’s variety.

One way to evaluate where we are today vs. in the seventies is to analyze the “misery index” -- only in economics could there be such a number! The misery index is the sum of the unemployment rate and year-over-year inflation, weighted by the GDP. The index hit a record of 22% in 1980, while this past January, the index weighed in at 9.2%, below the recent high of 9.8% in September, 2005. Clearly we are not near the historically nasty levels and of course, the seventies stagflation was exacerbated by the imposition and subsequent lifting of wage and price controls.

On the “flation” side of the equation, today there clearly is an upward shift in the real price of commodities, causing big pressure on inflation and downward pressure on growth. But this could be a temporary situation. As the economy cools, it takes time for the unemployment rate to rise and commodity prices to ease. As Greg Ip noted in the Wall Street Journal on Monday, although there is great fear surrounding the prospect of recession combined with inflation, “history suggests the two almost never happen at the same time. And that explains why the U.S. Federal Reserve, for now, has chosen to focus on the first threat rather than the second.”

To some extent, the Fed is betting that the current spike in prices is temporary. Last week, Ben Bernanke said that “inflation could be lower than we anticipate if slower-than-expected global growth moderates the pressure on the prices of energy and other commodities or if rates of domestic resource utilization fall more than we currently expect.” In order for the current inflation to become a larger problem, the idea of rising prices must become part of consumer and business expectations and thus far, those expectations have not increased too much. One final word: according to the WSJ, “inflation did fall after the recessions of 1969-70, 1973-75 and 1980.” Perhaps you need not find those platform shoes, Nehru jackets or bell bottom pants!