Goldilocks and Stagflation

‘Inflating the money supply now would only aggravate the situation,” Paul Volcker, Former chairman of US Federal Reserve.
Stagflation combines the worst extremes of a deflationary bust with an inflationary boom. Parts of the global economy risk entering a phase of stagflation – and Brexit could make the UK an early victim. Metaphorically speaking, if economic growth is the amount of porridge and inflation is its temperature, Goldilocks is being offered a portion that is both too small and too hot.
Stagflation occurred in a number of countries in the 1970s. Although inflation in those days reached double digits, the modern ‘trickle-down’ kind1 is more moderate. But at the zero-bound, it has the same effect in that it pushes both growth and returns into negative territory in real terms. Should loose monetary policies be joined by loose fiscal ones, inflation is likely to heat up, becoming a threat to investors chasing yields and growth.
In an earlier article on economic tides, I mentioned that I expect an interim phase of stagflation, between the current deflationary wave and a future tsunami of inflation. I believe the conditions that would facilitate such a transition are falling into place, although this form of stagflation will be weaker than that of the 1970s. I also believe that stagflation is more likely than secular stagnation. To make my general case, I paint with a broad brush while penciling the UK as a special case. I will focus on growth and inflation, as well as on issues of supply and demand. Let’s start with a brief summary of the current economic climate (as if we need reminding).

This post was published at FinancialSense on 08/05/2016.