The current times we live in are some of the most tumultuous in recent decades, barring the great recession, and this has come with a great deal of uneasiness when it comes to the future of our economy. There is an arising worry that because of the unsettled nature of the world, we may see stagflation in the future. In “Why Stagflation is a Growing Threat to the Global Economy” by Nouriel Roubini, Roubini outlines several key points regarding the future of our economy and our current practices. His main point is that Stagflation would come from the increased inflation caused by the “surplus” stimulus bills passed to ease the economic damage caused by the Covid19 pandemic. While this on its own would not lead to a stagflationary event, when combined with events that may occur in the future, we may see large unemployment and high inflation which was seen in the ’70s. The arguments against this are 1, that people will save much of the money, as they always do, and invest into infrastructure which will increase supply as demand increases, and 2 that banks can soak up the excess liquidity caused by the larger portion of liquid, or spendable money in people's pockets as a result of overcompensation for the covid crash. A central bank would do this by raising interest rates and forcing the liquidity of money to raise, however, with this second option, banks may not be able to soak up the liquidity, as the economy may demand a low interest rate to maintain stability. This seems to be backed up by Fed statements claiming that there are no plans currently or for some time to raise the interest rates. The third counterargument would be that the monetization of fiscal deficits will not be inflationary, rather it will only prevent inflation. What Roubini brings up regarding these is that we are recovering from a supply shock, much like the oil shocks of the 1970s. Our shock is a negative aggregate supply shock, as we have seen with the loss of many usually supplied goods because of covid. Problems that would deepen this potential stagflation (ie, supply shocks) would be deglobalization, rising protectionism, post-pandemic supply bottlenecks, deepening Sino-US cold war, and the balkanization of global supply chains and reshoring of foreign direct investment from low-cost China to higher-cost locations. (Roubini, 2021) More domestic sources of stress could be rising inequality, with more power given to producers in recent years, giving them more pricing power. While these looming problems may affect the macroeconomy eventually, currently the slack in markets for goods will prevent a sustained inflationary surge, however, loose monetary and fiscal policies will start to trigger persistent inflationary or stagflationary pressures, owing to the emergence of any number of persistent negative supply shocks.
I feel that it is important to quickly summate stagflation, as it is the centerpiece of this post. Stagflation is the name for when an economy experiences high inflation, and high unemployment at the same time. This would seem counter to what we have been learning about with the Phillips curve, and I will touch on that more later. On a typical Phillips curve, we would expect unemployment and inflation to have a negative relationship, with one going down and the other going up. A prime example to look at when thinking about stagflation would be the oil shocks to the US in the 1970s. This was a culmination of many different factors, but mainly it was caused by the embargo of the United States by OAPEC, because of their decision to resupply the Israeli military during the Yom Kippur war. OAPEC limited oil shipments to the US, and other countries. This increase in the cost of oil had several impacts on the US economy; first, it raised the cost of transportation for almost every good in the US, causing prices to rise, as gas naturally became more expensive, and secondly, it caused production to become more expensive, slowing economic growth. This raised inflation, and unemployment, leading to Stagflation. One US response was to devalue the dollar and declare wage and price freezing. During this time period, the US implemented many expansionary policies, and this helped lead to the rapid inflation of the time. Because the US was so liberal with allowing money to become more liquid, they were in the perfect position to go into a recession given a supply shock. The only way for the US to get out of this trap was to increase interest rates to double-digit levels, which caused a recession. (Neilson 2020) What this shows is that our current expansionary/reactionary policies toward the covid19 pandemic may have adverse ramifications regarding stagflation in multiple ways, and the only way to get out of it may be to cause a recession caused by increased interest rates. This would be extremely worrying currently because we are already experiencing large amounts of unemployment, and even though we are seeing growth, it is not backed up with equal or continued hiring of workers. There is also much liquid policymaking in the US as a means of support for those affected by the Covid19 pandemic.
The mention of stagflation brings into question the validity of the Phillips curve, which we have recently become familiar with. The core tenant of the Phillips curve is that you trade off unemployment for inflation, meaning that the higher your unemployment, the lower your inflation, and vice versa. This theory dominated US policymaking during the 1960s and led to inflation increasing from 1.2% in 1962, to 5.8% in 1970. (Dorn, 134) Unfortunately during the 1970s, we experienced shocks to the oil supply, which caused high unemployment and high inflation, which would seem to contradict the Phillips curve. Another theory which disputes the Phillips curve would be that of Milton Friedman, who theorized that there were three stages to the Phillips curve, with the first being the one we are most familiar with. This would be the curve in the short run and shows a simple negative relationship between unemployment and inflation. (Dorn 2021)
[FIGURE 1]
This however only applies during the short run. While a rise in inflation will bring down unemployment, during the short run, during the long run we would see employers and workers fully anticipate higher inflation, and they will revise their plans, causing unemployment to return to its natural level. For example in figure 2 we can see that when inflation rises to i1, it temporarily lowers unemployment, however, it is adjusted to the natural rate of unemployment of Nu once workers and employers recorrect. (Dorn 2021)
[FIGURE 2]
This would indicate that the Phillips curve is vertical, and there is no tradeoff between unemployment and inflation. The third stage which Friedman outlines would be the hypothesis that high and variable inflation lays the ground for higher future unemployment by distorting relative prices, producing a positively sloped long-run Phillips curve. This can be shown in figure3. (dorn 2021)
. [FIGURE 3]
What seems to be concerning several economists today is that it appears that those in charge of monetary policy seem to still find the Phillips curve compelling, and influential to further policymaking. Examples of this endorsement come from several different interviews with influential people, like Janet Yellen, and Fed Chairman Powell. (Dorn pg142) Our response to the Covid19 pandemic has been quick and powerful, with many stimulus packages and granting easy ways for money to move around in the economy, and while this has certainly saved us now, it may cause alarm in the future, and lay the groundwork for stagflation in the future. Essentially with our current predicament, we may see the beginning of a stagflationary period in the future. The ease of access to liquid money, and the excess of stimulus money paired with uncertainty caused by the pandemic may lead to the perfect backdrop to a stagflationary event. If these factors combine with a large shock to the economy, such as a further deepening of the trade war with China, or increased isolationism from countries globally, we may find ourselves seeing a repeat of the 1970s. This also brings into question the continued use of the Phillips curve in monetary policy-making. Should this be something we still use to help guide policy or is its continued use a trap? Is the US heading towards a stagflationary event, or should we just coast on out of this danger zone without experiencing these negative effects?
Resources
Catalan Vidal, J. (2017). The Stagflation Crisis and the European Automotive Industry, 1973-85. Business History, 59(1–2), 4–34. https://doi-org.ezproxy.plu.edu/http://www.tandfonline.com/loi/fbsh20
Dorn, James A. "The Phillips Curve: A Poor Guide for Monetary Policy." The Cato Journal, vol. 40, no. 1, 2020, p. 133+. Gale Academic OneFile, . Accessed 21 Apr. 2021.
Nielsen, Barry. “Stagflation in the 1970s.” Investopedia, Investopedia, 31 Mar. 2021, www.investopedia.com/articles/economics/08/1970-stagflation.asp.
Roubini, Nouriel. “Why Stagflation Is a Growing Threat to the Global Economy.” The Guardian, Guardian News and Media, 15 Apr. 2021, www.theguardian.com/business/2021/apr/15/why-stagflation-is-a-growing-threat-to-the-global-economy.
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