A Whiff Of Stagflation  

Paul Krugman's latest column looks at the signs of stagflation appearing and considers the various risks the world economy is exposed to.

What's driving inflation? Not wages: labor costs have been falling, because wages are growing less than productivity. Oil prices are a big part of the story, but not all of it. Other commodity prices are also rising; health care costs are once again on the march. And a combination of capacity shortages, rising Asian demand and a weakening dollar has given industries like cement and steel new "pricing power."

It all adds up to a mild case of stagflation: inflation is leading the Fed to tap on the brakes, even though this doesn't look or feel like a full-employment economy.

We shouldn't overstate the case: we're not back to the economic misery of the 1970's. But the fact that we're already experiencing mild stagflation means that there will be no good options if something else goes wrong.

Suppose, for example, that the consumer pullback visible in recent data turns out to be bigger than we now think, and growth stalls. (Not that long ago many economists thought that an oil price in the 50's would cause a recession.) Can the Fed stop raising interest rates and go back to rate cuts without causing the dollar to plunge and inflation to soar?

Or suppose that there's some kind of oil supply disruption - or that warnings about declining production from Saudi oil fields turn out to be right. Suppose that Asian central banks decide that they already have too many dollars. Suppose that the housing bubble bursts. Any of these events could easily turn our mild case of stagflation into something much more serious.

How do we get out of this bind? As the old joke goes, I wouldn't start from here. We should have spent the years of cheap oil encouraging conservation; we should have spent the years of modest growth in medical costs reforming our health care system. Oh, and we'd have a wider range of policy options if the budget weren't so deeply in deficit.