Issue of the week: Bracing for the scourge of ‘stagflation’

The economy isn’t as bad as you think—it’s worse, said Gerard Baker in the London Times. While political and business leaders have been focused on the credit crisis and the “deepening recession,” a new threat has emerged—“accelerating inflation,” which, coupled with an economic slowdown, is what economists call “stagflation.” Last week the U.S. government reported that inflation at the consumer level had increased “a more than slightly alarming 4.3 percent.” This week brought word that inflation at the wholesale level was surging as well, up 1 percent in January from the month before. And it’s not just “the usual suspects of oil and energy-related products” that are driving the inflation indexes higher. Prices are rising across the board. “This suggests that inflation is more than just spiking in relation to some short-term cost pressures.” It’s becoming embedded in the economy “in ways dangerously reminiscent” of the late 1960s and 1970s.

Inflation plus recession can be a killer, said Rich Miller in Bloomberg.com. Consumers are already feeling the squeeze, as credit card companies raise their rates and falling home prices make it harder to tap home equity. Housing prices in 20 U.S. metropolitan areas fell a staggering 7.7 percent

in November from a year earlier, according to data released last week. If that news wasn’t scary enough, the January home foreclosure rate jumped 8 percent from the prior month—and a heart-stopping 57 percent from a year earlier. It’s not surprising, then, that economist Allan Sinai foresees “a seismic shift” in consumer spending, which drives about three-quarters of the economy. “For several years,” Sinai predicts, “the growth of consumer spending is going to be significantly below its long-run average of 3.5 percent.” And slower spending will almost inevitably result in a slower-growing economy.

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For Federal Reserve Chairman Ben Bernanke, “all this could not come at a worse time,” said Graham Bowley in The New York Times. Ordinarily, the Fed would raise interest rates to choke off inflation. But “with the credit markets in disarray from the collapse of the housing bubble,” Bernanke has been busy cutting rates “in a headlong rush to blunt the risks of recession.” Now the Fed risks the worst of both worlds—a slowing economy that won’t respond to rate cuts, and higher prices for many goods, as China, India, and other fast-developing economies compete for resources.

We still have a way to go before we see a return of 1970s-style stagflation, said Chris Isidore in CNNmoney.com. Although it’s true that prices for oil, wheat, and many other commodities have risen sharply in recent months, “commodity prices have only a limited impact on the cost” of the goods we find on store shelves. Rising wages contribute much more to inflation, and “a weak job market should keep wages from rising sharply.” That’s no comfort to consumers, of course. And if that’s not discouraging enough, consider this: Any wage gains that consumers do manage to eke out this year could be eaten up by rising prices. “In other words, even if the economy doesn’t actually decline, it may feel like it has.”