The threat of stagflation

Turn on the TV, radio, social media, news sites, and podcasts and the COVID-19 virus story is topic number 1 through 100 with only the weather report offering relief. The pandemic has both disrupted and ended people’s lives.

The federal government is facing the momentous task of reversing the effects of the resulting recession with a combination of expansionary fiscal and monetary policy. On the fiscal side, rescue spending, financed with gobs of new debt, prevented further deterioration of the economy. On the monetary side, the Federal Reserve has pursued both traditional and unconventional policies.

The public debt of the United States has risen quickly over the last several months. From Feb. 20, 2020 through June 20, 2020, the government’s total public debt has increased by about $3.068 trillion from $23,409 trillion to $26,477 trillion. While the federal government has gone on a borrowing binge and approved huge relief spending, the Federal Reserve is creating huge amounts of dollars that end up paying for the debt.

Lurking behind the easing of monetary policy is the fear that too much money chasing too few goods will lead to inflation, thereby decreasing the purchasing power of the dollar. Once the crisis is over, there is the prospect of prices and inflation accelerating simultaneously, or what people of a certain age will remember as stagflation.

In other words, one potential economic consequence of deficit-financed public spending and the Federal Reserve’s emergency lending programs and interest rate cuts is the threat of inflation in a post Covid-19 economy. Among other things, inflation eats away at the purchasing power of people’s paychecks.

It also disrupts people’s behavior, causing demand-pull inflation. Suppose a rise in prices sets off rumors that prices will increase still more. This is common during inflationary times, when the increasing prices of goods lead people to expect that prices will be even higher tomorrow. People rush in, causing prices to go higher still. People buy more of a product when inflation is rampant, anticipating that the price will only rise more.

Meanwhile, firms selling the products see prices go up and decide not to take advantage of good times by increasing their offerings, but instead hold back, waiting for tomorrow. Thus demand goes up and supply goes down.

At its worst, the entire economy goes out of control, as happened in the 1970s. After several decades of unprecedented growth, signs of a slowdown emerged amid events such as sudden oil price spikes in 1973 and 1979, and increased global competition precipitated important economic changes. In the hope of inflating the economy out of unemployment, the government printed tons of money.

The economy was stuck between a rock and a hard place. Economists called the twin phenomenon of stagnating growth and double- digit inflation: “stagflation.” In 1979, President Jimmy Carter appointed Paul Volcker to chair the Federal Reserve Board. He pursued tight monetary policies, pushing interest rates over 20 percent, with the desired consequence of a steep and prolonged business recession breaking the back of runaway inflation. By 1986, inflation almost disappeared entirely.

The legendary philosopher king of baseball, Yogi Berra, allegedly once said: “It’s tough to make predictions, especially about the future.” Still, many financial mavens are fretting and speculating about the danger of price inflation resulting from money being printed at a frenetic pace in the United States. They fear the country may be entering an era of double-digit inflation similar to the 1970s and that stagflation may return to the daily lexicon.

As John Maynard Keynes wrote, “Lenin is said to have declared that the best way to destroy the capitalist system was to debauch the currency. By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens.”

Americans can only hope that Lenin was wrong or misquoted, and they will not experience the return of stagflation. Time will tell if the inflation mongers are right.

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