Is stagflation making a comeback?

When I talk to business groups these days, the most commonly asked question is, “Are we headed for stagflation?” I’m pretty sure they find my response unsatisfying, because I tell them it depends on their definition of the term.

If they understand it to mean a period of rising unemployment combined with inflation that’s still too high, the answer is that there’s a very good chance we’ll suffer from that malady for at least a few months. But if they’re referring to something like the extreme pain we suffered to close out the 1970s, it looks unlikely.

To explain the difference, consider two historical episodes.

First, look at 1979 to ’80, which illustrates what I suspect most people have in mind when they talk about stagflation. At the beginning of 1979, the United States already had 9% annual inflation; the surge in oil prices after the Iranian revolution sent inflation well into double digits. The Federal Reserve, under Paul Volcker, responded with drastically tighter monetary policy, leading to a recession and a sharp rise in unemployment.

The recession brought inflation down but not enough, so the Fed tightened the screws further, sending the economy into a double dip. This finally did bring inflation down to around 4%, considered acceptable at the time, but at immense cost: Unemployment peaked at 10.8% in 1982 and didn’t get back down to 1979 levels until 1987.

Now consider the period from 2007 to the fall of 2008, just before the demise of Lehman Bros. On the surface it looks somewhat similar, with uncomfortably high inflation, brought on by rising oil and other commodity prices, and surging unemployment.

And a fair number of influential people worried about runaway prices more than the recession. According to the transcript of the August 2008 meeting of the Federal Open Market Committee, which sets monetary policy, there were 322 mentions of inflation and only 28 of unemployment.

Yet inflation subsided quickly. And while there was a severe recession — still generally known as the Great Recession — it had nothing to do with squeezing inflation out of the economy and everything to do with the fallout from a severe financial crisis.

What was the difference between these episodes? At the beginning of the 1980s, inflation was deeply entrenched in the economy, in the sense that everyone expected high inflation not just in the near term but also for the foreseeable future; companies were setting prices and negotiating wage deals on the assumption of continued high inflation, creating a self-fulfilling inflationary spiral. It took a huge, sustained uptick in unemployment to break that spiral.

In 2008, by contrast, while people expected high inflation in the near future — probably because they were extrapolating from higher gasoline prices — their medium-to-long-term expectations about inflation remained fairly low.

So there wasn’t any inflationary spiral to break.

Where are we now? Consumer inflation expectations now look a lot like those of 2008 and nothing at all like those of 1979 to ’80: The public now expects high inflation for the near term but a return to normal inflation after that. Financial markets, where you can extract implied inflation expectations from the spread between yields on bonds that are and aren’t indexed to consumer prices, are telling the same story: inflation today but not so much tomorrow.

In short, inflation doesn’t seem to be entrenched; 2022 isn’t 1980.

Nonetheless, I do expect to see some rise in unemployment. While we don’t seem to be in an inflationary spiral, many indicators suggest that the economy is currently running too hot to be consistent with price stability. Higher wages are good, but they seem to be rising at an unsustainable pace; unlike in 2008, inflation isn’t confined to a few areas, so that even measures that exclude the extremes are running high.

So the Fed has to do what it’s doing, raising interest rates to cool things down, and it’s hard to see how that cooling happens without at least some increase in the unemployment rate. Will the slowdown be sharp enough to be considered a recession? I don’t know, and the truth is nobody does. But it doesn’t really matter. We’re probably headed for a period of weakening labor markets while inflation is still elevated, and many commentators will surely proclaim that we’re experiencing stagflation.

But such proclamations, while technically true, will be misleading. When people hear “stagflation,” most think of the late 1970s and early ’80s — but there’s no evidence that we’re facing anything comparable now.