That 70's Feeling
Ben Bernanke may be facing a nasty relic of the disco era. It's called stagflation
Give me a one-handed economist," President Truman once supposedly demanded of his White House staff. "All my economists say, 'On the one hand ... on the other.'" Good thing Truman isn't sitting in the Oval Office these days. He might be dealing with an awfully exasperating fellow-the dreaded three-handed economist.
On the one hand, the economy looks as if it might be headed into deep trouble, even a recession. The bubblicious housing market, a critical support for the economy in recent years, is clearly popping. Home sales have fallen to their lowest levels since 2004, while the number of homes sitting on the market is at a 10-year high. And luxury home builder Toll Brothers-whose stock price has been halved during the past year-last week reported a 19 percent drop in profits from a year earlier.
Things don't look much livelier for the auto industry. GM and Ford both have recently announced production cuts, and sales are down more than 9 percent from last year. Then there is the economy-dampening impact of 17 straight interest-rate increases by the Federal Reserve before the central bank finally paused earlier this month. Indeed, the nation's gross domestic product grew by just 2.5 percent in the second quarter, down sharply from 5.6 percent in the first quarter. "The economy is in worse shape than after the tech bust in 2000," says Nouriel Roubini, a New York University economics professor who also runs his own consulting firm. He thinks there's a 70 percent chance that the economy is headed toward a recession.
But then there's the other hand: Prices keep going up. During the first seven months of 2006, the consumer price index rose at a 4.8 percent seasonally adjusted annual rate. That compares with an increase of 3.4 percent for all of 2005. Rising oil prices were a big reason for that, of course. Yet even excluding food and energy, inflation still rose 3.1 percent, up from a 2.2 percent rise for all of 2005.
Core problems. Many economists saw good news, though, in the inflation stats for July. Core CPI came in at 0.2 percent after rising 0.3 percent in each of the prior four months. But, as economist Dean Baker of the Center for Economic and Policy Research points out, if you factor out the seemingly anomalous 1.2 percent drop in apparel prices in July, core inflation would have been 0.3 percent again.
This isn't how the economy is supposed to work. Weaker demand should translate into prices rising more slowly, if at all. But that's not been happening. So here's where the "third hand" comes in: The U.S. economy seems to be experiencing a bout of stagflation. It's a rare, worst-of-both-worlds situation where economic growth and employment stagnate yet inflation rises. The clunky term was coined by economists in the 1970s to describe the terrible mix of sluggish growth, soaring unemployment, and high inflation that then plagued the American economy. In 1974, for instance, the U.S. economy shrunk 0.5 percent and unemployment rose to 7.2 percent, even though prices skyrocketed 11 percent. Oil shocks, loose Federal Reserve monetary policy, and out-of-control government spending have all been blamed for the stagflation. The economic mess culminated in America's worst economic downturn since the Great Depression.