STAGFLATION IN U.S. INTRODUCTION An article from “The New York Times” published on Febuary 13 th , 2011 mentioned that: “In the USA, CONGRESS has made a terrible mistake. Amid a rhetorical debate centered on words like “crisis,” “emergency” and “catastrophe,” it acted too fast. While arguments were made about the stimulus bill’s specific components — taxpayer money for condoms, new green cars and golf carts for federal bureaucrats, another round of rebate checks — its more dangerous consequences were overlooked. And now the package threatens a return to the kind of stagflation last seen in the 1970s. From a global perspective, the picture only looks worse. As we have debated how much money to borrow and spend in hopes of jump-starting our economy, we’ve ignored the worldwide stimulus binge. China, Europe and Japan are all spending hundreds of billions of dollars they don’t have in hopes of speeding up their economies, too. That means the very countries we have relied on to buy our bonds, notably China and Japan, are now putting their own bonds on the global credit markets. It seems that no one in Washington is discussing what happens when the world begins this gargantuan borrowing spree. How high will interest rates rise? And more fundamentally, who will have the money to buy our bonds? It is possible that the Federal Reserve will succumb to pressure to “monetize” our debt — that is, print new money to buy our bonds. In fact, the Fed is already suggesting that it will buy long-term Treasury securities in order to lower borrowing costs. If it does, then our money supply, which has already increased substantially over the past year, will grow even faster. To American families, inflation is a destroyer of savings, a killer of wealth, a crusher of confidence. It calls into question the value of our money. And while we all share in the pain, the people whom inflation hits hardest are elderly people who live on fixed incomes, those in the middle class who are struggling to save for retirement and college and lower-income people who live paycheck to paycheck. Combine high inflation and high unemployment and you have stagflation. Hindsight shows how the pain of the late 1970s and early 1980s could have been avoided, yet we’re now again planning to borrow and spend — and raise taxes — as President Jimmy Carter did. Soon we may again find ourselves watching a rising “misery index” of inflation and unemployment together. If that happens, individual earning power will evaporate, and our standard of living will decline….” [Type text] Page 1 STAGFLATION IN U.S. Obviously, we are entering an era of high inflation, to judge by the massive growth of the money supply in the United States, Europe and Asia, and the stubbornness of central bankers who insist that high unemployment demands the creation of even more money. The last time the world went through a similar period was the 1970s. The term that defined the era was "stagflation." Thus because the 1970s stagflation did do great harm to the U.S. economy and global economy as a whole, followed by a period of recesssion and there are evidences that we are on our way to the replay of stagflation nowadays, a thorough understanding of stagflation is crucially important for individuals as well as policy-makers to make reasonable decisions. The urgency of this trend has led us to choose “Stagflation in the U.S.” as the topic of our assignment. In this study, we will give a clear definiton of stagflation. Besides, a deep analyse is made on the factual situation of the 1970s Great Stagflation and more recently, especially the main causes that leads to stagflation in the period. Lastly, we will come up with some recommendations for individual decisions and implementation of government’s policies. We hope that through the arguments and data in our paper, you could gain comprehensive understanding, including basic and in-depth knowledge, about the issue and be more confident, more active when making decisions in today economic situation. [Type text] Page 2 STAGFLATION IN U.S. CONTENTS I. Definition II. Facts 1. Facts of stagflation in the 1970s 2. Fears of stagflation return III. Causes 1. General causes 2. Causes of stagflation in the 1970s 3. Explanation for risks of stagflation return IV. Recommendations 1. Increasing aggregate supply 2. Long-term stock pick 3. Commodity investment 4. International system of buffer stocks [Type text] Page 3 STAGFLATION IN U.S. I. DEFINITION The generally agreed-upon stagflation definition is a state of the economy that exhibits elevated unemployment rates and inflation at the same time. Typically, stagflation presents serious problems for monetary policymakers, since the remedies for high unemployment are nearly directly opposed to the remedies available for inflationary cycles. Most economists believe stagflation can be attributed to either failed economic policies or to destructive or catastrophic events that seriously affect the production capability of the overall economy. During the 1970s, for instance, the United States experienced a prolonged period of stagflation due primarily to shortages of raw materials. Livestock feed manufacturing was significantly impacted by the loss of the Peruvian anchovy fishery in 1972, but the most significant economic factor was likely the oil crisis of 1973, when OPEC severely limited the international oil supply in order to control prices and boost profits for their members. Regardless of its origins, stagflation is likely to cause significant and prolonged economic problems that cannot be easily resolved. High unemployment reduces the overall buying power of consumers and companies, and increasing prices lessen that buying power even more. This can put a financial squeeze on both the consumer and the corporate sector and cause still more unemployment as companies try to compensate for lower profits, increasing expenses and the resulting reduction in financial liquidity. II. FACTS 1. STAGFLATION IN THE 1970s People often refer to the 1970s stagflation as ‘the bad old days’. When they think of the U.S. economy in that time the following comes to mind first: o Recession o Inflation o Unemployment o High oil prices In the following parts, we will look more closely into some economic indicators, including Economic Growth Rate, Inflation Rate and Unemployment Rate, in order to identify Stagflation in this period of US history. [Type text] Page 4 STAGFLATION IN U.S. a. Historical Economic Growth The 1970s were perhaps the worst decade of most industrialized countries', including the U.S.’s economic performance since the Great Depression. Although there was no severe economic depression as witnessed in the 1930s, economic growth rates were considerably lower than postwar decades between 1945 and 1973. U.S. manufacturing industries began to decline as a result, with the US running its last trade surplus (as of 2009) in 1975. In this paper, Economic growth is measured by Gross Domestic Product (GDP) in current dollars (i.e. Nominal GDP) and in year 2005 dollars (i.e. Real GDP). As can be seen from the table and graph, in the 1970s and 1980s, US economy experienced several periods of contraction: 1974 GDP contracted 0.55%, 1975: 0.21%, 1980: 0.28% and 1982: 1.94%. For the other years, real growth rate remained relatively small (less than 6%), with an exception of 1984 with a rate of 7.19%, indicating a period of slow growth and economic contraction. Annual Current-Dollar and "Real" Gross Domestic Product 1960-2000 Year GDP Year GDP GDP in billions of current dollars GDP in billions of chained 2005 dollars Real Growth rate % GDP in billions of current dollars GDP in billions of chained 2005 dollars Real Growth rate % 1960 526.4 2,828.5 1975 1,637.7 4,875.4 -0.21% 1961 544.8 2,894.4 2.33% 1976 1,824.6 5,136.9 5.36% 1962 585.7 3,069.8 6.06% 1977 2,030.1 5,373.1 4.60% 1963 617.8 3,204.0 4.37% 1978 2,293.8 5,672.8 5.58% 1964 663.6 3,389.4 5.79% 1979 2,562.2 5,850.1 3.13% 1965 719.1 3,607.0 6.42% 1980 2,788.1 5,834.0 -0.28% 1966 787.7 3,842.1 6.52% 1981 3,126.8 5,982.1 2.54% 1967 832.4 3,939.2 2.53% 1982 3,253.2 5,865.9 -1.94% 1968 909.8 4,129.9 4.84% 1983 3,534.6 6,130.9 4.52% 1969 984.4 4,258.2 3.11% 1984 3,930.9 6,571.5 7.19% 1970 1,038.3 4,266.3 0.19% 1985 4,217.5 6,843.4 4.14% 1971 1,126.8 4,409.5 3.36% 1986 4,460.1 7,080.5 3.46% 1972 1,237.9 4,643.8 5.31% 1987 4,736.4 7,307.0 3.20% 1973 1,382.3 4,912.8 5.79% 1988 5,100.4 7,607.4 4.11% 1974 1,499.5 4,885.7 -0.55% 1989 5,482.1 7,879.2 3.57% 1990 5,800.5 8,027.1 1.88% Table 1: U.S. Annual Current-Dollar and "Real" Gross Domestic Product (1960-2000) Source: http://www.bea.gov/national/xls/gdplev.xls [Type text] Page 5 STAGFLATION IN U.S. Figure 1: U.S. Annual Current-Dollar and "Real" Gross Domestic Product (1960-2000) b. Historical Inflation Rates Table 2 shows Inflation Rate data for the USA during the time 1959-2000, including monthly and annual rates. Year over Year compares the growth rate of the Consumer Price Index (CPI-U) from one period to the same period a year earlier. The oil shocks of 1973 and 1979 added to the existing ailments and conjured high inflation throughout much of the world for the rest of the decade. Before the year 1970, annual inflation rates mainly stayed below 3%. However, at the start of the new decade, the figure had more than doubled itself 10 years earlier, then slowing down at around 4% in the following 2 years. In 1974, there was a sharp rise in US inflation rate when it reached its highest of 11.04% in the last 15-year period. The buying power of money decreased remarkably and consumers were not willing to buy anymore. From 1975 to 1978, the rate went between relatively high levels of 7.6% and 9.1%, before reaching a double-digit figure again in 1979, breaking the 1974 record and soar to a new peak of 13.5% in 1980. In late 1980s, the situation became stable with the rate being kept under 5%. Year Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Annual 1965 0.9709% 0.9709% 1.2945% 1.6181% 1.6181% 1.9355% 1.6077% 1.9355% 1.6077% 1.9293% 1.6026% 1.9231% 1.6129% [Type text] Page 6 STAGFLATION IN U.S. 1966 1.9231% 2.5641% 2.5559% 2.8662% 2.8662% 2.5316% 2.8481% 3.4810% 3.4810% 3.7855% 3.7855% 3.4591% 2.8571% 1967 3.4591% 2.8125% 2.8037% 2.4768% 2.7864% 2.7778% 2.7692% 2.4465% 2.7523% 2.4316% 2.7356% 3.0395% 3.0864% 1968 3.6474% 3.9514% 3.9394% 3.9275% 3.9157% 4.2042% 4.4910% 4.4776% 4.4643% 4.7478% 4.7337% 4.7198% 4.1916% 1969 4.3988% 4.6784% 5.2478% 5.5233% 5.5072% 5.4755% 5.4441% 5.7143% 5.6980% 5.6657% 5.9322% 6.1972% 5.4598% 1970 6.1798% 6.1453% 5.8172% 6.0606% 6.0440% 6.0109% 5.9783% 5.4054% 5.6604% 5.6300% 5.6000% 5.5703% 5.7221% 1971 5.2910% 5.0000% 4.7120% 4.1558% 4.4041% 4.6392% 4.3590% 4.6154% 4.0816% 3.8071% 3.2828% 3.2663% 4.3814% 1972 3.2663% 3.5088% 3.5000% 3.4913% 3.2258% 2.7094% 2.9484% 2.9412% 3.1863% 3.4230% 3.6675% 3.4063% 3.2099% 1973 3.6496% 3.8741% 4.5894% 5.0602% 5.5288% 5.9952% 5.7279% 7.3810% 7.3634% 7.8014% 8.2547% 8.7059% 6.2201% 1974 9.3897% 10.0233% 10.3926% 10.0917% 10.7062% 10.8597% 11.5124% 10.8647% 11.9469% 12.0614% 12.2004% 12.3377% 11.0360% 1975 11.8026% 11.2288% 10.2510% 10.2083% 9.4650% 9.3878% 9.7166% 8.6000% 7.9051% 7.4364% 7.3786% 6.9364% 9.1278% 1976 6.7179% 6.2857% 6.0721% 6.0491% 6.2030% 5.9701% 5.3506% 5.7090% 5.4945% 5.4645% 4.8825% 4.8649% 5.7621% 1977 5.2158% 5.9140% 6.4401% 6.9519% 6.7257% 6.8662% 6.8301% 6.6202% 6.5972% 6.3903% 6.7241% 6.7010% 6.5026% 1978 6.8376% 6.4298% 6.5546% 6.5000% 6.9652% 7.4135% 7.7049% 7.8431% 8.3062% 8.9286% 8.8853% 9.0177% 7.5908% 1979 9.2800% 9.8569% 10.0946% 10.4851% 10.8527% 10.8896% 11.2633% 11.8182% 12.1805% 12.0715% 12.6113% 13.2939% 11.3497% 1980 13.9092% 14.1823% 14.7564% 14.7309% 14.4056% 14.3845% 13.1327% 12.8726% 12.6005% 12.7660% 12.6482% 12.5163% 13.4986% 1981 11.8252% 11.4068% 10.4869% 10.0000% 9.7800% 9.5526% 10.7618% 10.8043% 10.9524% 10.1415% 9.5906% 8.9224% 10.3155% 1982 8.3908% 7.6223% 6.7797% 6.5095% 6.6815% 7.0640% 6.4410% 5.8505% 5.0429% 5.1392% 4.5891% 3.8298% 6.1606% 1983 3.7116% 3.4884% 3.5979% 3.8988% 3.5491% 2.5773% 2.4615% 2.5589% 2.8601% 2.8513% 3.2653% 3.7910% 3.2124% 1984 4.1922% 4.5965% 4.8008% 4.5639% 4.2339% 4.2211% 4.2042% 4.2914% 4.2701% 4.2574% 4.0514% 3.9487% 4.3173% 1985 3.5329% 3.5156% 3.7037% 3.6857% 3.7718% 3.7608% 3.5543% 3.3493% 3.1429% 3.2289% 3.5138% 3.7987% 3.5611% Table 2: U.S. Annual and Monthly Inflation Rates (1965-1985) Source: http://www.rateinflation.com/inflation-rate/usa-historical-inflation-rate.php?form=usair [Type text] Page 7 STAGFLATION IN U.S. Figure 2: U.S. Annual Inflation Rate (1959-2000 Year-over-Year) c. Unemployment Rate Here's a look at the U.S. unemployment rate for people aging 16 and over for selected years from 1960 to 2000. Throughout the 1970s and 1980s, unemployment rate was quite high in comparison with the percentage of 3.5% of 1969, which created a significant social burden for the economy. This might be the result of production contraction or reflected a level of minimum wage lower than expected. The rate fluctuated continuously during the period, creating ups and downs, however, was above 5% for most of the time. It kept hitting new records: 8.5% in 1975, 9.7% in 1982 and 9.6% in 1983. [Type text] Page 8 STAGFLATION IN U.S. Unemployment Rate (%) 1960-2000 Year Rate Year Rate Year Rate 1960 5.5 1972 5.6 1984 7.5 1961 6.7 1973 4.9 1985 7.2 1962 5.6 1974 5.6 1986 7.0 1963 5.6 1975 8.5 1987 6.2 1964 5.2 1976 7.7 1988 5.5 1965 4.5 1977 7.1 1989 5.3 1966 3.8 1978 6.1 1990 5.6 1967 3.8 1979 5.9 1991 6.9 1968 3.6 1980 7.2 1992 7.5 1969 3.5 1981 7.6 1993 6.9 1970 5.0 1982 9.7 1994 6.1 1971 6.0 1983 9.6 1995 5.6 Table 3: U.S. Unemployment Rate (1960-1995) Source: http://data.bls.gov/pdq/SurveyOutputServlet Figure 3: U.S. Unemployment Rate (1960-2000) [Type text] Page 9 STAGFLATION IN U.S. As previously analyzed, we can see that the period of late 1970s and early 1980s is a typical example of stagflation of the economy, which is the combination of low growth rate, in other words the “stag”, together with high inflation and unemployment rate, or the “flation” in the term. By the time of 1980, when U.S. President Jimmy Carter was running for re- election against Ronald Reagan, the misery index (the sum of the unemployment rate and the inflation rate) had reached an all-time high of 21.98%. The economic problems of the 1970s would result in a sluggish cynicism replacing the optimistic attitudes of the 1950s and 1960s. Faith in government was at an all-time low in the aftermath of Vietnam and Watergate, as exemplified by the low voter turnout in the 1976 United States presidential election. 2. FEAR OF STAGFLATION RETURN In the 1970s, stagflation shocked traditional Keynesian economists, whose models said the economy could not suffer from both high unemployment and rapid inflation at the same time. Unfortunately, the Keynesians were wrong, because an economy obviously can experience both evils simultaneously. The typical view is that an economy in a deep recession is in no danger of price inflation. This belief is wrong both in theory and in practice. The worst bout of inflation during the postwar period occurred during the economic slump of the late 1970s and early 1980s. More seriously, there is a fear of stagflation return. According to the The Wall Street Journal from February 2008, “The U.S. is facing an unwelcome combination of looming recession and persistent inflation that is reviving angst about stagflation, a condition not seen since the 1970s” At the beginning of 2008, inflation was rising. The Labor Department said consumer prices in the U.S. jumped 0.4% in January and was up 4.3% over the past 12 months, near a 16-year high. Even stripping out sharply rising food and energy costs, prices rose 0.3% in January, driven by education, medical care, clothing and hotels. They was up by 2.5% from the previous year, a 10- month high. Some readers may remember the “misery index,” the sum of the unemployment and inflation rates. The official unemployment rate in 2009 averaged 9.3 percent, for a total misery-index rating of 12.0. This is the highest misery rating in 26 years, going all the way back to 1983 when it was 13.4. Prices rose 2.7 percent during 2009, according to the Bureau of Labor Statistics’ recent update of the Consumer Price Index (CPI), signalling a return of “stagflation”, a merger of stagnation and inflation. [Type text] Page 10 [...]... caused a surge in consumer price index [Type text] Page 17 STAGFLATION IN U.S (CPI) inflation of more than 5% in major emerging markets such as China, Brazil and Indonesia, with the dollar prices of primary commodities rising more than 40% world-wide over the past year So the proximate cause of the rise in U.S prices is inflation in emerging markets, but its true origin is in Washington There is a second,... (SMEs) enabling them to purchase labor and other supplies In cyclical upswings, SMEs have traditionally been the main engines for increasing employment, but not in the very weak upswing of 2010-11, where employment gains have been meager or nonexistent Why should zero interest rates be causing a credit constraint? After all, conventional thinking has it that the lower the interest rate the better credit... recovery from the recession In the long-run, the rapid economic growth of China and India along with the arrival of peak oil production, spell nothing but higher energy costs In other words, it is the return of stagflation Figure 6: Gasoline Price In 2011 Dollars [Type text] Page 12 STAGFLATION IN U.S Figure 7: Food-Price Index (1980 – 2010) Since both Gasoline price and Food price are indexed to inflation,... in his message to Congress that ‚if unemployment were to rise the programme of unemployment insurance ‚automatically [Type text] Page 16 STAGFLATION IN U.S would act to sustain personal income He had therefore undermined in advance his capacity to attack inflation through increasing unemployment and reducing personal incomes For his policies, if they did not reduce incomes as much as the increase in. .. reflected in the sharp fall in interbank lending: Interbank loans outstanding in March 2011 were only a third of their level in May 2008, just before the crisis hit How to fix bank intermediation is a long story for another time But it is clear that the Fed's zero interest-rate policy has worsened the situation Without more lending to SMEs, domestic economic stagnation will continue even though inflation... prices when they fell to too low a level by buying on the market (which would help incomes in developing nations and other producing nations), and to lower prices by selling into the market when prices were rising too high (Kaldor 1976: 228–229) In short, Post Keynesian economics can easily understand and deal with stagflation The wageprice spirals that broke out by the end of the 1960s in some industrialized... based on the Keynesian school of economic thought, named after twentieth-century British economist John Maynard Keynes Nevertheless, in the 1970s, Keynesian economists had to reconsider their beliefs as the U.S and other industrialized countries entered a period of stagflation b High oil price in the 1970s The 1973 oil crisis started in October 1973, when the members of the OAPEC (consisting of the Arab... [Type text] Page 19 STAGFLATION IN U.S They are interested in the type of taxes levied as well as the tax rate Low marginal income tax rates allow people to keep more of what they earn, perhaps encouraging them to work more hours This would increase aggregate supply Low tax rates on profits as well as special investment tax breaks encourage investment in plants and equipment that also increase aggregate... suggest that the government stop regulated the safety of drugs or automobiles Supply-siders argue that there is too much regulation, in the past 25 years they have supported the deregulation of the financial sector, the airlines, and communications They currently support the deregulation of the electric/natural gas utilities d Infrastructure investment Recall that infrastructure refers to the transportation,... people to find safe places to put their wealth Inflation makes the money stored in bank accounts less valuable as prices rise faster than any interest payments can keep up with As well, the stock market will be depressed due to the stagnant economy Investing in long-term stock picks may be the only wise course among many poor options 3 COMMODITY INVESTMENT [Type text] Page 21 STAGFLATION IN U.S In the past, . stagflation in the 197 0s 2. Fears of stagflation return III. Causes 1. General causes 2. Causes of stagflation in the 197 0s 3. Explanation for risks of stagflation return IV. Recommendations 1. Increasing. decline as a result, with the US running its last trade surplus (as of 2009) in 1975. In this paper, Economic growth is measured by Gross Domestic Product (GDP) in current dollars (i.e. Nominal. 1973 resulted in actual or relative scarcity of raw materials. The price controls resulted in shortages at the point of purchase, causing, for example, queues of consumers at fueling stations and