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Is the United States Likely to Enter a Period of Stagflation?

Sean Duffin

No. While inflation could continue to run hotter than central banks expect, the US employment situation is improving, and economic growth is unlikely to stagnate.

Stagflation refers to an environment of persistently high inflation, elevated unemployment, and subpar economic growth. This type of economic scenario is extremely rare, primarily because it is very unusual to see consumer prices rise amid high unemployment rates and recession-like growth. Still, the most notable environment of stagflation in the United States was in the 1970s as energy shocks led to double-digit inflation and a 9% unemployment rate. Today, inflationary pressures and worries about a growth slowdown have sparked concerns that the United States could be entering a similar period of stagflation.

Inflation has surged amid impaired supply chains, elevated energy prices, rising rents, and resurgent consumer demand. The headline US Consumer Price Index rose 6.2% in the 12 months through October and has expanded at more than 5% year-over-year in each of the past six months, well above the Federal Reserve’s long-term target of 2%. The central bank has acknowledged that inflation has come in higher than expected and these price pressures are likely to persist well into next year. Heading into 2022, the Fed has a wide scope to tighten monetary policy from rock-bottom policy rates and has indicated plans to use these tools as necessary to get inflation under control. But this will be a delicate balance for the Fed, as supply chain imbalances are not likely to be resolved quickly and could keep persistent pressure on prices.

Signs of a growth slowdown intensified in the third quarter, but the outlook looks more stable. Real US economic growth decelerated to just 2.0% annualized in the third quarter, down from 6.7% in the second quarter. However, expectations have jumped well above what might be considered stagnant. Economists now expect fourth quarter GDP to advance 4.9%, with full-year 2022 estimates indicating 4.0% growth, nearly double the growth the United States experienced in 2019.

The more optimistic growth outlook is buoyed by strength in the labor market. In October, the US economy added 531,000 jobs, a major rebound from September. The economy has now recovered 80% of jobs lost during the pandemic. Moreover, the unemployment rate has dropped from 14.8% to 4.6% in just 16 months since April 2020. Demand for workers is high; the ratio of unemployed persons per job opening is now at 0.8, back to pre-pandemic levels, after surging as high as 5 in April 2020. This indicates that there is at least one job opening in the United States for every unemployed worker, which matches a record. Wages are starting to climb, which could entice more workers back to the labor force. While higher wages can drive inflation upward, they almost always lead to higher consumption and GDP growth.

Overall, while stagflation has crept back into the daily lexicon of many market observers, it is unlikely that we will see a combination of factors that drive the economy into another 1970s-style stagflation scenario. We acknowledge that inflation could overshoot as supply chain imbalances persist. However, economic growth is unlikely to stagnate given a tightening labor market. Of course, these dynamics will also depend on how and if the Fed uses monetary policy to rein in inflation without undercutting the economic recovery.