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Key Takeaways
- Several economic forecasts now call for the U.S. economy to enter a period of "stagflation," which involves stagnant economic growth and high inflation.
- Tariffs may increase consumer prices, while also slowing the growth rate. This squeezes household budgets in two directions as the job market continues to deteriorate.
- The central banks have a difficult time combating stagflation by monetary policy because they can only make it worse.
If the U.S. economic system avoids a recession caused by tariffs then economists see a growing risk of financially painful “stagflation.”
Forecasters remain divided over whether President Donald Trump’s recent trade wars will cause the economy to enter a recession. Even if the economy avoids a recession, many forecasts have highlighted risks of “stagflation,” a period of high economic growth and high inflation. Many forecasters including officials from the Federal Reserve predict tariffs will slow the economic growth and hurt job markets while driving up consumer price.
Lindsey Piegza of Stifel Financial is one of those who believes the job market and consumer expenditure are resilient enough for the economy to avoid a recession from trade wars. This assumes the recently announced tariffs will be negotiated down.
However, that doesn't mean everything will be rosy for the economy. She believes the economic growth for the next couple of quarters will be close zero.
She said, “You’re basically at a nonaccelerating economy. If we see this non-acceleration persist into the second half, I think that a prolonged period stagflation poses a significant risk to the U.S. economic system.” “I would say this is the greater risk than a downturn or recession.”
Piegza’s not the only prominent economic figure to sound the stagflation warning. Adam Posen of the Peterson Institute for International Economics brought up the issue in a Foreign Affairs article this week. The U.S. could have the same effect as a complete ban on trade if it raised tariffs against China from 45% to 145%, he wrote.
“The supply-shock from drastically reducing or eliminating imports from China as Trump purports he wants to achieve would mean stagflation. The macroeconomic nightmare that was seen in the 1970s during the COVID-19 Pandemic and when the economy shrank, and inflation rose simultaneously,” Posen said.
How bad is the stagflation problem? In the 1970s, when the U.S. last experienced a period of high inflation with slow growth, economists developed a method to measure it. The “misery index” is a combination of both the inflation rate as well as the unemployment rate. The name refers both to the difficulties people face when prices are increasing and finding work in an economy that is stagnant.
The Fed has struggled with stagflation historically
As tough as stagflation can be on everyday household budgets, it's also not a walk in the park for central bankers.
Their main tool for influencing the economy—monetary policy—can help fight inflation or boost the job market, but not both at the same time. The Fed can lower its benchmark fed fund rate to boost the economic growth, but may be reluctant to do this if inflation is above the central bank’s 2% target. The Fed could increase rates to combat inflation, but this would damage a job market that is already hurting.
In a Wednesday speech, Federal Reserve chair Jerome Powell acknowledged in his speech the difficulty of combating stagflation. He called it “a challenging scenario.”
Piegza said that “stagflation puts policymakers in a corner, making traditional monetary policies metrics that would have been used to stimulate the economic essentially useless.” “The Fed is likely to raise interest rates in an effort to curb inflation. The economy is already very sluggish. And vice versa. “I think that stagflation poses the greatest risk to the U.S. economic system at this time.”
