Thursday, February 21, 2008

What Is Stagflation?

There is a lot of talk going around about stagflation, but many people have no idea what stagflation is. The term has only been around for about 40 years and is not used all that much, but suddenly it is being thrown around everywhere.

Stagflation is a blend of the words stagnation and inflation. It is used to describe an economy which is stagnating (or not growing) while also facing high inflation.

Typically, the Fed deals with economic stagnation by lowering key interest rates or adding to the money supply. These actions usually work to get the economy growing again.

On the flipside, when an economy is booming and people are making money left and right, inflation begins to rise. When this happens, the Fed typically raises interest rates thus making money harder to get. This slows the economy and inflation with it. So back to Stagflation…

In a period of stagflation, the Fed doesn’t know what to do. The economy is slow, so they want to lower interest rates and get it moving, but making money easier to get only makes inflation worse. The Fed has to decide what is more important: economic growth or inflation.

Right now, the U.S. economy is grinding to a halt, and very likely heading into a recession. Unfortunately we are also facing strong inflationary pressure as prices continue to rise (see inflation post). If we aren’t already in a period of stagflation, then it appears that we are headed straight for it. The last time the U.S. dealt with stagflation was in the 1970’s and it was not a fun experience.

Though the way we run are economy now is different than it was back then, some would argue that our current situation (housing and credit crisis) is far worse then the situation was in the 70’s leading up to that period of stagflation. I don’t know how bad it can get, but something worse than the 15 percent inflation and 9 percent unemployment seen during the past episode of stagflation doesn’t sound the least bit exciting to me. Personally, I will be heavily diversifying into foreign markets and things like gold and silver to protect myself, just in case.

1 comment:

Anonymous said...

The goverment answer to stagflation is retail therapy $600.00 for all!