A few months ago, the term ‘stagflation’ was mentioned too casually and frequently, in my opinion. Investors were worried about the impact of a trade war, which is natural, but were too quick to go to “The S Word.”
Stagflation is a portmanteau of stagnation and inflation, coined in the 1970s when economic growth was very low (and sometimes negative) and inflation was very high. The term stagnation was often used interchangeably with the Misery Index, which combined inflation and unemployment.
To put some context around stagflation, I created the chart below, which combines economic growth with inflation.
To create this chart, I first examined the history of real (or inflation-adjusted) economic growth for each quarter. Although the chart starts in 1960, the data begins in 1950, as I believe it is important to have ten years of data before drawing any inferences about it.
Each data point after the first ten years is compared to the average data point since 1950 and the volatility of those readings. I do the same thing with inflation, and then take the average of the two series to make the chart. The shaded yellow periods are recessions, as marked by the National Bureau of Economic Research (NBER).
I think the simplest way to understand the chart is to call any reading on the x-axis between one and negative one as ‘normal.’ I will define deflation as a prolonged period when the growth and inflation readings are below -1.
Although there were brief periods in 1990 and 2022 when this data fell below -1, I don’t think they lasted long enough to be considered stagflation, which is why I included the word “prolonged.”
Ultimately, that leaves us with three severe episodes in the 1970s, although I would agree with an argument that the whole period was engulfed by stagflation, even if it wasn’t always below -1.
From the beginning of the chart in 1960, the average real annual growth rate was 3.1%, and the average inflation rate was 3.8%. If we look at the averages for the periods where my chart is below -1, real economic growth is -2.1 percent, and the average inflation rate is 9.1 percent. You can see the problem and why everyone is afraid of stagflation!
For further context, let’s compare 2022 and the mid-1970s. I was no fan of 2022 for many reasons, but using my definition of stagflation without the prolonged qualifier, it lasted only six months. The average growth reading was -0.3, which is poor, but the average inflation rate was 8.8 percent, which was extremely high (as we all recall).
If we look at the middle episode of the 1970s, it alone lasted two full years. The average real growth was -1.0 percent, and the average inflation was 10.2 percent. I’m not downplaying 2022, but it was a lot more destructive to have a worse contraction with higher inflation for four times as long in the 70s.
I draw a few conclusions from this chart. First, whatever you might hear in the media, the data does not show anything close to stagflation at this point. Many people expect lower growth and higher inflation, but a slowdown in the former and an acceleration in the latter could both occur without leading to the magnitude of stagflation seen in the 1970s.
Of course, I don’t prefer any hint of slower growth or higher inflation, but I think it’s critical to clarify the magnitude of the problem.
Then there is the duration. Again, I won’t like it if we have an episode like we had in 2022 that only lasts six months, but that’s a whole lot better than what happened throughout the 1970s.
In my view, there is reason for concern about growth and inflation in the short term since there are more risks today than in the past few years. Still, it’s not easy to see at the moment how today’s economy transitions quickly from relatively normal to genuine stagflation.
We’ll have to wait and see, but I’m not ready to accept the stagflation doomsday prognostications.
