The Recession is On, but Will It Include Inflation?
THE FOLLOWING COMMENTARY WAS DELIVERED OVER WAMC RADIO ON MARCH 7, 2008 by MICHAEL MEEROPOL
Last Thursday, Fed Chairman Ben Bernanke1 and President Bush both asserted they did not believe the US economy would fall into recession in 2008.
Then on Sunday the Business section of The New York Times ran three articles that seemed designed to completely contradict Bush and Bernanke. The first of two front page articles asserted that the recent recovery has seen job growth insufficient to reach the levels of employment in 2000.2
"Some 62.8 percent of all Americans age 16 and older were employed at the end of [2007] down from the peak of 64.6 … in early 2000." The second noted that "… a consumer-led recession has already begun, according to a new index that reflects how much money Americans can actually spend right now." 3
While the Federal Reserve has taken strong steps to stimulate the economy with a one and one quarter percentage cut in the Federal Funds Rate over the last two months - and promises more of the same - the federal government for now seems unwilling to provide more fiscal stimulus. President Bush opposed the efforts of some Congressional Democrats to come up with a second stimulus package focusing on infrastructure spending. He stated: "I know there's a lot of, you know [talk about] … - stimulus package II and all that. Why don't we let stimulus package I, … have a chance to kick in?" 4
Meanwhile, the efforts to combat the recession with fiscal and monetary stimulus may be complicated by the potential re-emergence of a problem our economy has not seen since 1980 - and that is stagflation.
What is "stagflation"? It's a combination of too much unemployment - too slow growth - perhaps even a recession and unacceptably high rates of inflation.5
Consider the difference between our situation today in 2008 and the early months of 2001 when the Federal Reserve and the Federal Government combined expansionary monetary policy with significant tax cuts in an attempt to head off a recession.
In 2000 and 2001, the rate of inflation measured 3.4 and 2.8 percent. After the recession began the rate fell to 1.6% in 2002.6 In that situation, the Fed, the President and Congress were able to stimulate the economy without accelerating inflation.
Now, we have a situation where the inflation rate was 3.2% in 2006 and 2.8% in 2007.7 If inflation continues to fall as it did in 2002, policy makers will be free to give the economy as much gas as it needs to reverse the downturn and get us on the road to recovery.
However, there are scary signs that this will not be easy. Gasoline prices have risen dramatically over the last few years and there are predictions of $4 a gallon gas this summer. The preliminary monthly figure on inflation for is .5% per cent which if continued for the next 11 months will bump the year's inflation rate up to 6%.8 (Compare that to 1.6% in 2002.) Bernanke's testimony on Thursday noted that "Consumer price inflation has increased since [July] in substantial part because of the steep run-up in the price of oil. Last year, food prices also increased significantly, and the dollar depreciated…. inflation excluding food and energy prices-- … [increased] toward the end of the year."
He concluded that, "The higher recent readings likely reflected some pass-through of energy costs to the prices of core consumer goods and services as well as the effect of the depreciation of the dollar on import prices." 9
If inflation does not fall significantly, it will make it very difficult for the Fed, the President and Congress to increase the vigor with which they combat the recession. That's because everything they do to combat the recession might increase inflation.10 2008 is not going to be an easy year for any of us - policy-makers included.
Footnotes:
1 See "Is a Lean Economy Turning Mean? Why It's Now Even Harder to Find Job" and "The Buck Has Stopped," The New York Times (March 2, 2008): Business Section, p. 1. See also "The Jump-Start That Hasn't Started," The New York Times (March 2, 2008): Business Section, p. 6. Then, the day after this commentary aired, March 8, 2008, The New York Times had two front page stories that made clear we are already in a recession: "Sharp Drop in Jobs Adds to Grim Economic Picture" and "End to the Good Times (Such as they Were)." The second article concluded with a really dismal picture of the past six years of economic recovery, "The median household earned $48,201 in 2006, down from $49,244 in 1999." [p. A9]. The 1999 figure is at the top of the recent business cycle before the stock market crash of 2000 and the recession of 2001 reduced income. The fact that median household income did not grow over a full business cycle is extraordinary. It means that the recent growth in consumption has mostly been fueled by debt expansion. This means that the decline in consumption will be quite significant because people have already borrowed a great deal and may have little room to borrow more.
2 "Is a Lean Economy Turning Mean?": p. 8.
3 "The Buck Has Stopped": p. 1.
4 See http://www.foxnews.com/story/0,2933,333553,00.html. The full statement from President Bush would have been impossible to really follow without the insertions I put into the text. Here it is verbatim from the transcript: 'It's - I know there's a lot of, you know - here in Washington, people are trying to, you know - stimulus package II and all that. Why don't we let stimulus package I, which seemed like a good idea at the time, have a chance to kick in?"
5 The decade of the 1970s was marred by stagflation. Here is the data:
Date Unemployment Rate (in percent) Inflation Rate (in percent)
1970 4.9 5.7
1971 5.9 4.4
1972 5.6 3.2
1973 4.9 6.2
1974 5.6 11.0
1975 8.5 9.1
1976 7.7 5.8
1977 7.1 6.5
1978 6.1 7.6
1979 5.8 11.3
1980 7.1 13.5
[Source: Economic Report of the President, 2004: 330, 357.]
Note the persistence of high levels of unemployment through much of the decade accompanied by surges in inflation 1973, 74 and 1978, 79 and 80.
6 See Economic Report of the President, 2006: 355. For some strange reason the number I spoke on the air was incorrect. I said 1.5% when I should have said 1.6%.
7 See the Bureau of Labor Statistics Table at ftp://ftp.bls.gov/pub/special.requests/cpi/cpiai.txt
8 The January figure is on the Bureau of Labor Statistics' front page: http://www.bls.gov/cpi/home.htm
9 See http://www.fxstreet.com/fundamental/interest-rates/ben-s-bernanke-testimony-before-the-committee-on-f/2008-02
On other issues he commented as follows:
Discussion on the housing market: "The housing market is expected to continue to weigh on economic activity in coming quarters. Homebuilders, still faced with abnormally high inventories of unsold homes, are likely to cut the pace of their building activity further, which will subtract from overall growth and reduce employment in residential construction and closely related industries."
Discussion on the economic outlook: "The risks to this outlook remain to the downside. The risks include the possibilities that the housing market or labor market may deteriorate more than is currently anticipated and that credit conditions may tighten substantially further."
10 The tools of monetary and fiscal policy mostly affect aggregate demand - either the consumption spending of individuals, the investment spending of businesses or the government's own spending. Expansionary monetary and/or fiscal policy (reduced interest rates by the FED, a stimulus package passed by Congress) will increase spending if it is effective. However, any increase in spending might make it easier for businesses to raise prices - and in the context of rising oil prices and other business costs, they will have a strong incentive to do that. Should the FED and Congress try to restrain inflation by raising interest rates or cutting government spending (this is what Congress and the FED did early in 1980), that could have the effect of making the recession deeper. During the 1970s, government policy shifted from anti-inflationary to expansionary and back again. There was even a period of direct wage and price controls in 1971 and 1972. For details see SURRENDER, chs. 3, 4, 5.
Last Thursday, Fed Chairman Ben Bernanke1 and President Bush both asserted they did not believe the US economy would fall into recession in 2008.
Then on Sunday the Business section of The New York Times ran three articles that seemed designed to completely contradict Bush and Bernanke. The first of two front page articles asserted that the recent recovery has seen job growth insufficient to reach the levels of employment in 2000.2
"Some 62.8 percent of all Americans age 16 and older were employed at the end of [2007] down from the peak of 64.6 … in early 2000." The second noted that "… a consumer-led recession has already begun, according to a new index that reflects how much money Americans can actually spend right now." 3
While the Federal Reserve has taken strong steps to stimulate the economy with a one and one quarter percentage cut in the Federal Funds Rate over the last two months - and promises more of the same - the federal government for now seems unwilling to provide more fiscal stimulus. President Bush opposed the efforts of some Congressional Democrats to come up with a second stimulus package focusing on infrastructure spending. He stated: "I know there's a lot of, you know [talk about] … - stimulus package II and all that. Why don't we let stimulus package I, … have a chance to kick in?" 4
Meanwhile, the efforts to combat the recession with fiscal and monetary stimulus may be complicated by the potential re-emergence of a problem our economy has not seen since 1980 - and that is stagflation.
What is "stagflation"? It's a combination of too much unemployment - too slow growth - perhaps even a recession and unacceptably high rates of inflation.5
Consider the difference between our situation today in 2008 and the early months of 2001 when the Federal Reserve and the Federal Government combined expansionary monetary policy with significant tax cuts in an attempt to head off a recession.
In 2000 and 2001, the rate of inflation measured 3.4 and 2.8 percent. After the recession began the rate fell to 1.6% in 2002.6 In that situation, the Fed, the President and Congress were able to stimulate the economy without accelerating inflation.
Now, we have a situation where the inflation rate was 3.2% in 2006 and 2.8% in 2007.7 If inflation continues to fall as it did in 2002, policy makers will be free to give the economy as much gas as it needs to reverse the downturn and get us on the road to recovery.
However, there are scary signs that this will not be easy. Gasoline prices have risen dramatically over the last few years and there are predictions of $4 a gallon gas this summer. The preliminary monthly figure on inflation for is .5% per cent which if continued for the next 11 months will bump the year's inflation rate up to 6%.8 (Compare that to 1.6% in 2002.) Bernanke's testimony on Thursday noted that "Consumer price inflation has increased since [July] in substantial part because of the steep run-up in the price of oil. Last year, food prices also increased significantly, and the dollar depreciated…. inflation excluding food and energy prices-- … [increased] toward the end of the year."
He concluded that, "The higher recent readings likely reflected some pass-through of energy costs to the prices of core consumer goods and services as well as the effect of the depreciation of the dollar on import prices." 9
If inflation does not fall significantly, it will make it very difficult for the Fed, the President and Congress to increase the vigor with which they combat the recession. That's because everything they do to combat the recession might increase inflation.10 2008 is not going to be an easy year for any of us - policy-makers included.
Footnotes:
1 See "Is a Lean Economy Turning Mean? Why It's Now Even Harder to Find Job" and "The Buck Has Stopped," The New York Times (March 2, 2008): Business Section, p. 1. See also "The Jump-Start That Hasn't Started," The New York Times (March 2, 2008): Business Section, p. 6. Then, the day after this commentary aired, March 8, 2008, The New York Times had two front page stories that made clear we are already in a recession: "Sharp Drop in Jobs Adds to Grim Economic Picture" and "End to the Good Times (Such as they Were)." The second article concluded with a really dismal picture of the past six years of economic recovery, "The median household earned $48,201 in 2006, down from $49,244 in 1999." [p. A9]. The 1999 figure is at the top of the recent business cycle before the stock market crash of 2000 and the recession of 2001 reduced income. The fact that median household income did not grow over a full business cycle is extraordinary. It means that the recent growth in consumption has mostly been fueled by debt expansion. This means that the decline in consumption will be quite significant because people have already borrowed a great deal and may have little room to borrow more.
2 "Is a Lean Economy Turning Mean?": p. 8.
3 "The Buck Has Stopped": p. 1.
4 See http://www.foxnews.com/story/0,2933,333553,00.html. The full statement from President Bush would have been impossible to really follow without the insertions I put into the text. Here it is verbatim from the transcript: 'It's - I know there's a lot of, you know - here in Washington, people are trying to, you know - stimulus package II and all that. Why don't we let stimulus package I, which seemed like a good idea at the time, have a chance to kick in?"
5 The decade of the 1970s was marred by stagflation. Here is the data:
Date Unemployment Rate (in percent) Inflation Rate (in percent)
1970 4.9 5.7
1971 5.9 4.4
1972 5.6 3.2
1973 4.9 6.2
1974 5.6 11.0
1975 8.5 9.1
1976 7.7 5.8
1977 7.1 6.5
1978 6.1 7.6
1979 5.8 11.3
1980 7.1 13.5
[Source: Economic Report of the President, 2004: 330, 357.]
Note the persistence of high levels of unemployment through much of the decade accompanied by surges in inflation 1973, 74 and 1978, 79 and 80.
6 See Economic Report of the President, 2006: 355. For some strange reason the number I spoke on the air was incorrect. I said 1.5% when I should have said 1.6%.
7 See the Bureau of Labor Statistics Table at ftp://ftp.bls.gov/pub/special.requests/cpi/cpiai.txt
8 The January figure is on the Bureau of Labor Statistics' front page: http://www.bls.gov/cpi/home.htm
9 See http://www.fxstreet.com/fundamental/interest-rates/ben-s-bernanke-testimony-before-the-committee-on-f/2008-02
On other issues he commented as follows:
Discussion on the housing market: "The housing market is expected to continue to weigh on economic activity in coming quarters. Homebuilders, still faced with abnormally high inventories of unsold homes, are likely to cut the pace of their building activity further, which will subtract from overall growth and reduce employment in residential construction and closely related industries."
Discussion on the economic outlook: "The risks to this outlook remain to the downside. The risks include the possibilities that the housing market or labor market may deteriorate more than is currently anticipated and that credit conditions may tighten substantially further."
10 The tools of monetary and fiscal policy mostly affect aggregate demand - either the consumption spending of individuals, the investment spending of businesses or the government's own spending. Expansionary monetary and/or fiscal policy (reduced interest rates by the FED, a stimulus package passed by Congress) will increase spending if it is effective. However, any increase in spending might make it easier for businesses to raise prices - and in the context of rising oil prices and other business costs, they will have a strong incentive to do that. Should the FED and Congress try to restrain inflation by raising interest rates or cutting government spending (this is what Congress and the FED did early in 1980), that could have the effect of making the recession deeper. During the 1970s, government policy shifted from anti-inflationary to expansionary and back again. There was even a period of direct wage and price controls in 1971 and 1972. For details see SURRENDER, chs. 3, 4, 5.
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