Stagflation: Does the U.S. Have It Today?

The following is the third guest article from professor Jeff Wiltzius, an economics professor and a long-time friend of mine. As I mentioned in July when I published his first article, Prof. Wiltzius has graciously offered to write a few articles for DepositAccounts.com to share his insights into the economy and the Fed.

Stagflation: Does the U.S. Have It Today? Will the U.S. Economy Soon Encounter Stagflation?

by Prof. Jeff Wiltzius

In recent posts to DepositAccounts.com, it became clear that some people do not have a clear understanding of the term stagflation. Stagflation was coined to describe a stagnant economy with inflationary pressure. In short, inflation and unemployment are occurring in the economy at the same time. So does the U.S. have stagflation at this point in time? The economy certainly has unemployment, so it has half of the requirements of stagflation. But technically, based on the official core CPI inflation measurements of 1.4%, it does not have the other half of the requirements for stagflation. So technically, no, the U.S. economy is not experiencing stagflation.

Ironically, the official version of the economy does not reflect what most people in the U.S. are experiencing. Most Americans are dealing with some parts of inflation in their microeconomic circumstances. These people do not care about the official macroeconomic version that inflation is under control. The reason for the discrepancy is that the core inflation numbers leave out the volatile sectors of food and energy costs. The data is what statisticians would refer to a skewed, simply put; the data reflects the impact of a small group of households on the entire population.

The top quintile (20% - households earning over $130,000 a year) of household income earners consume roughly half of the goods and services produced. This group is not affected in the same way by the volatile food and energy costs (gas prices) as the rest of Americans. When the majority of Americans, the bottom 50% of household income earners see gas prices go from $2.00 a gallon to $3.00, to almost $4.00 a gallon in the last five years, they feel it at the pumps. When hamburger goes up almost 15% in two years (U.S. Bureau of Labor Statistics, July 16, 2013) middle income Americans believe, and rightly so, that inflation exists because the prices of the necessities that they buy have sky rocked much higher than the 1.4% inflation rate.

Lower income families feel it even more. The choices become even harder. Faced with the choice of buying needed medication, or food for your children, either choice may have dire consequences no matter which option is chosen. When gas prices take up the entire household transportation budget, required maintenance on the car may be foregone. Normally inexpensive foods, like chicken leg quarters that could have been bought for thirty-nine cents a pound a couple years age in Florida, now run seventy eight cents a pound at discount store prices: that is double! For low to middle income families when prices on staples that are a normal part of their budget double, that is not inflationary levels, that is hyperinflationary (very high rates of inflation) levels.

Transportation has never been considered volatile like the food and energy sectors, but some recent events have made parts of the transportation sector fluctuate. The transportation sector is more difficult to interpret statistically because it includes a broad spectrum of transportation expenses, like: train, airlines, auto insurance and many other costs of transportation. An automobile is still most household’s biggest expense in transportation and is another area that has become more costly for middle income families while remaining affordable for the top quintile. One reason is President Obama’s stimulus plan that included Cash for Clunkers (Car Allowance Rebate System). Economists question government policies because usually there are unintended consequences associated with of the policies that are implemented. The Cash for Clunkers Program is a great example of the law of unintended consequences.

Designed to lower pollution emissions and stimulate new car sales. Many environmental groups have questioned whether there were any positive environmental benefits to the Cash for Clunkers program. That is beyond this economist’s realm of expertise. For that information see a study by Li, Linn, and Spiller at Resources of the Future (www.rff.org). What can be measured from an economic standpoint are two things. First, did the Cash for Clunkers program work as economic stimulus? Second, what were the long term unintended consequences of the program?

Look at what happened to used car prices after the Cash for Clunkers program hit in 2009. The yellow line shows an increase in used car and truck prices of more than 25% in two years. The spike in 2005 was caused by Hurricane Katrina and there would be another spike caused by Hurricane Sandy in 2012 if this data went further. All of these increases have hurt the middle income Americans the hardest. The blue line shows that the top quintile, the people who can afford new cars have almost no effect from inflationary pressure. Studies have indicated that roughly half of the new cars that were sold would have been sold regardless of the program, but $3 billion worth of used cars being scrapped certainly affected the used car market. So the program had little impact in terms of economic stimulus, but it had a major impact in terms of inflationary pressure for buyers of used cars.

Then there is that other part of the Consumer Price Index that all Americans are subject to, health care costs. These costs are now over twenty percent of the U.S. economy and health care costs have been rising at more than twice the core inflation rate. The projections for the future are that health care costs will continue to rise at more than twice the inflation rate as the U.S. population becomes older, which increases the demand for health care. The demand for health care is very inelastic because it is a necessity, so patients don’t shop for a better price, don’t question costs because of insurance, and buy the procedures even if the price is high. So far efforts to curb costs in the U.S. have failed.

So does the U.S. economy have stagflation; definitely not. The statistics simply do not support that fact. But if you are a middle income American looking at double digit increases in food, energy, medical care, and transportation costs, then it definitely feels like inflation. If you are an unemployed American facing double digit increases in food, energy, medical care, and transportation costs, then you are definitely experiencing stagflation. So does stagflation exist in America? Unfortunately for some, the answer is yes.

The next important question: is stagflation coming? In this economists opinion stagflation in the near future (3-5 years) is a definite possibility. The “quantitative easing forever”, the Federal Reserve is continuing to put $80 billion dollars a month into the monetary system, could be the primary cause of future stagflation. Virtually all economist agree that the primary cause of inflation is “printing” (the FED does not physically print money, the majority of the money supply is on electronic balance sheets) too much money. It is also this economist’s position that the primary problem in the U.S. economy is fiscal policy, out of control government spending, not monetary policy. If fiscal policy is the problem, then monetary policy changes cannot solve the problem. The current monetary policy can, in fact, cause the problem to become worse in the future. Unfortunately, with gridlock on Capitol Hill continuing with the current budget talks, there seems to be no relief in sight for the American people.