The Economy Is Headed For Stagflation. But This Time It's Different

The U.S. economy might be headed for a bout of ’70s-style stagflation, but economists expect it to be far less severe this time around.

Many forecasters say the U.S. is entering a period of slow economic growth combined with accelerating inflation. At the root of the phenomenon are President Donald Trump’s tariffs, which are pushing up consumer prices and slowing down the job market at the same time.

However, economists expect this bout of inflation to be much less severe than the double-digit annual price increases that plagued household budgets in the 1970s.

Get Ready For ‘Stagflation Lite’

On Friday, the government’s Personal Consumption Expenditure report showed that inflation is higher than the Federal Reserve’s goal of 2% per year. And next week’s report on employment is expected to show lackluster job growth.

“Investors must come to grips with inflation above the Fed’s target amid a backdrop of slower growth, setting things up for stagflation-lite,” Jeffrey Roach, chief economist at LPL Financial, wrote in a commentary in mid-August.

The term “stagflation” is a portmanteau of “stagnation” and “inflation” coined to describe the miserable economic conditions of the 1970s and early 1980s when the U.S. experienced high inflation and soaring unemployment rates at the same time.

Stagflation differs from a typical recession, where the economy crashes and prices fall in response. Economists have recently tacked on “lite” to indicate they don’t expect the coming bout of stagflation to be nearly as bad as the one a half-century ago.

“This ‘Stagflation Lite’ environment will, in our view, continue to show slowing and below-trend growth coupled with uncomfortable and rising price pressures into year-end,” RBC Bank economists Frances Donald and Carrie Freestone wrote in a commentary Monday.

For example, Mark Zandi, chief economist at Moody’s Analytics, forecast inflation, as measured by core PCE prices, to peak at a 3.5% annual increase in the coming year. That’s well above the Federal Reserve’s target of a 2% annual rate, but nothing compared to the 70s stagflation, when core PCE inflation surged over 10%.

Similarly, Zandi predicts the economy, as measured by Gross Domestic Product, will grow at an annual rate of 1%. That’s less than half of the 2.5% average since 2010, but it would avoid an outright downturn that could lead to a recession.

What The Fed Can Do

Federal Reserve Chair Jerome Powell hinted at stagflation risks, without using the word, in his landmark speech at the Jackson Hole economic summit last week.

Many economists expect the bout of stagflation lite to be mild and short-lived, unlike the 70s malaise.

Chengjun Chris Wu, senior portfolio manager at Federated Hermes, said as much in a blog post last week.

“Eventually, stagflation-lite will give way, either because inflation soars or because economic growth returns,” Wu wrote. “Full-blown stagflation is rare and likely to stay that way.”

However, Zandi warned that correcting stagflation might require the Federal Reserve to use the same harsh medicine it did to jolt the economy out of it in the 70s. It raised the benchmark interest rate to a high enough level to restrict economic growth and stamp out inflation.

Whether the Fed can do that may depend on how independent it stays from politics. President Donald Trump has demanded that the Fed lower interest rates and has increasingly pressured policymakers to do so. Trump could gain more influence over the Fed in May when the current term of Fed Chair Jerome Powell expires and Trump appoints a successor.

“A reasonable question is whether the Fed will remain sufficiently independent after Powell’s term is up in May,” Zandi wrote.