Worst of both worlds: Are the risks of stagflation elevated?

Summary

In this first report of a three-part series, we present a framework to characterize historical episodes of stagflation into mild, moderate or severe episodes.

Iain Macleod coined the term "stagflation" during an address to the House of Commons in 1965: “We now have the worst of both worlds—not just inflation on the one side or stagnation on the other, but both of them together.”

Stagflation can impose significant stress on the economy and can be a difficult situation to escape. Elevated inflation erodes consumer purchasing power, while weaker demand leads to a deterioration in the labor market, thereby limiting the opportunity for real wage gains.

Conventional monetary or fiscal policy actions are remedies that often improve stagnation or inflation, but not both.

The most salient episode of stagflation in modern U.S. history occurred in the 1970s. A perfect storm of energy price shocks, robust labor cost growth and elevated government spending led inflation to spiral, while economic output faltered and unemployment rose.

While we could debate on the fairness of that comparison, the exercise of comparing bouts of stagflation led us to develop a simple framework to organize historical episodes on a severity scale.

In data that span 1950 to present, we identified 13 instances of stagflation. Five episodes are mild, four are moderate and four are severe. The shortest episodes lasted two quarters, occurring in 1977-1978 and 1995, and the longest episode occurred in 1979-1982 (16 quarters).

In the next installment of this series, we summarize past episodes of stagflation and their accompanying monetary policy decisions.

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