“Until recently, the rich world was see-sawing between stagflation and inflation. When the crisis was at its worst, output took a nosedive but it was deflation, not inflation, that was the greatest concern. Then economies recovered, as did assets – including commodities, whose prices have pushed inflation out of policymakers’ comfort zone. Now both sides of the dreaded 1970s portmanteau threaten to come together as production slows down while prices continue apace. Stagflation has gone from unpleasant memory to present danger.” ‘Editorial, ‘Haunted by stagflation fears’, The Financial Times, April 30, 2011
The evidence acknowledged by the FT editor is fairly compelling. In the United Kingdom, first-quarter growth in 2011 at only 2 per cent per annum, followed on a fourth quarter 2010 contraction, while inflation ran at an annualised rate of some 5 per cent. In the United States, first quarter 2011 growth ran at an annualized rate of only 1.8 per cent, slowing from a 3.1 per cent annualized rate in the fourth quarter of 2010, while inflation, inclusive of commodity prices, exceeded the Fed’s 2 per cent ceiling.
The FT, relying on hydraulic Keynesian thinking, draws sustenance from the fact that both the UK and the US economies are running below full capacity, arguing that loose money is less likely now than in the 1970s to fuel runaway inflation. It forgets, conveniently, that 1970s inflation occurred against high and rising unemployment rates in both countries. ‘Inflation is always and everywhere a monetary phenomenon” (Milton Friedman).
The FT, forgetful as always of recent history, draws further sustenance from the fact that rising commodity prices are driven more by micro-economic forces of demand and supply than by loose money, by Middle East shocks rather than by Bad Ben Bernanke. Do the years 1974 and 1079 not ring any bells in FT ears? The fact is that economic shocks ripple through any economy. In an environment of loose money, price inflation is the mechanism whereby market equilibria return. That is what stagflation was all about during the 1970s and what stagflation will be all about in the coming decade.
This gives hope that if the rich world suffers a mild case of stagflation, it is a temporary symptom of inevitable economic shifts.” ibid.
I am afraid that such is not the case, Mr. FT editor. Stagflation is a response to loose money and it will be brought to an end, only painfully and with long and variable lags, by a systematic tightening of monetary policy, designed to raise real interest rates to market-clearing levels. Once inflation-expectations are released from their cage, it is the Devil’s own work to put them back in, as Paul Volcker will readily testify. Unfortunately for the world’s economy, Ben Bernanke is no Paul Volcker, though he may stand at the left hand side of Satan.