How likely is a stagflation scenario?
In this commentary Cecchetti and Schoenholtz discuss the lessons learned from the 1970s stagflation. They make the following observations:
- The fact that inflation was kept low from 1990 to 2020 boosted the credibility of policymakers’ commitment to price stability. As a result, even in the presence of adverse supply shocks, people expect trend inflation to remain low, so it does. On the contrary, in the 1970s people did not generally believe that the Fed was committed to keeping low.
- Thanks to massive fiscal and monetary policy stimulus and the availability of vaccines, aggregate demand recovered rapidly in 2021. Consequently, supply chains and local labor shortages led to increased costs, drove up prices as well as measured inflation. If demand outpaces supply for longer and by more than policymakers foresee, the increase in inflation could become persistent.
Our conclusion is simple. Persistent stagflation is a problem central banks know how to prevent. While they cannot keep adverse supply disturbances from driving growth down and raising prices temporarily, they can prevent transitory increases in inflation from becoming permanent. The key is that the public believes in monetary policymakers’ commitment to price stability and supports necessary monetary policy restraint even when the short-run costs may be high.
Stagflation: A Primer
By: Stephen G. Cecchetti, Kermit L. Schoenholtz – Brandeis University, New York University
Do people believe the Fed is committed to price stability?
In this commentary John Cochrane elaborates on the point Cecchetti and Schoenholtz put forth in the commentary above: do people believe the Fed is committed to price stability? He doesn’t think so:
The Fed continues to follow the opposite strategy: a determined effort to stimulate the economy and to raise inflation and inflation expectations, by promising no-matter-what stimulus. The Fed is still trying to deter deflation, and says it will let inflation run above target for a while in an attempt to reduce unemployment, as it did in the 1970s. It has also precommitted not to raise interest rates for a fixed period of time, rather than for as long as required economic conditions remain, which has the same counterproductive result as announcing military withdrawals on specific dates. Like much of the US government, the Fed is consumed with race, inequality, and climate change, and thus is distracted from deterring its traditional enemies.
Inflation in the Shadow of Debt
By: John Cochrane – Stanford University
Is China a future source of deflation?
[W]ith the near bankruptcy of the developer Evergrande, China is at the beginning of a real estate crisis. This is reminiscent of the Japanese crisis of the 1990s. At the time, the bursting of the asset bubble, both in equities and in real estate, forced the private sector, households and corporates, to deleverage their balance sheets. This paved the way for a long period of mild deflation with inflation rates close to zero, and weak growth. The Chinese central bank, in close collaboration with the Bank of Japan, has been studying the Japanese case closely and decided on a liquidity injection on September 27. Unfortunately, awareness is no guarantee to take the right decisions at the right time. If for political or market reasons Chinese private companies were to engage in a race for debt clearance, the Japanese scenario would become more likely. Especially since today’s China shares another characteristic with Japan at the time: demographic decline. This could make China a deflationary factor in the world economy.
A Whiff of Stagflation in the Economic Recovery
By: Eric Chaney – Institut Montaigne
