When inflation and recession gang up on the economy
When inflation and recession gang up on the economy
The whiplash from the Donald Trump administration’s on-again, off-again tariff policy is leading to a lot of uncertainty on Wall Street and stirring worries that an old economic menace, stagflation, could be lurking around the corner. Stagflation is essentially a macroeconomic cocktail of rising prices, high unemployment and recession.
To be clear, the U.S. economy is not currently grappling with that dismal condition. Unemployment in February remained historically low at 4.1%. Inflation, while elevated, is down significantly from its pandemic highs. But at the same time, sweeping tariffs could create an environment in which stagflation might take root.
“We all know that tariffs, because it’s a tax, it’s going to lead to higher prices, but we didn’t know there’s going to be so much uncertainty about it,” said Şebnem Kalemli-Özcan, a professor of economics at Brown University and director of the Global Linkages Lab. “That creates a lot of uncertainty about economic outlook in the future, which means now consumers are going to cut down their demand, investors are going to cut down their investment. And that’s the recession part of the stagflation.”
“Marketplace” host Kai Ryssdal spoke with Kalemli-Özcan about the risk of stagflation and the challenge it poses for central bankers. The following is an edited transcript of their conversation.
Kai Ryssdal: For those who might not have experienced it back in the 1970s, what does stagflation feel like in an economy?
Şebnem Kalemli-Özcan: It is basically higher prices and higher unemployment, recession. So you have a double whammy. The economy is slow, people are unemployed. At the same time, prices are high.
Ryssdal: We are not in stagflation right now, that is an important point. But my question is, what has happened to get us to the point where we’re having this conversation again?
Kalemli-Özcan: Why we are having this conversation is what I call extreme uncertainty created by a series of policies of the new administration. We all know that tariffs, because it’s a tax, it’s going to lead to higher prices, but we didn’t know there’s going to be so much uncertainty about it. You know, back and forth, back and forth. That creates a lot of uncertainty about economic outlook in the future, which means now consumers are going to cut down their demand, investors are going to cut down their investment. And that’s the recession part of the stagflation.
Ryssdal: What do we do about it? I mean, if, if you’re Jay Powell listening to this interview — I don’t know if he’s going to listen — but what do you tell the head of the [Federal Reserve] to do?
Kalemli-Özcan: The Fed’s role here is look at what happens to expectations, to inflation expectations, because the future plans of businesses and consumers is going to be reflected in that inflation expectations. And if Jay Powell sees those expectations are elevated, but at the same time the data — which is, of course, always about the past — that inflation is not going down, we are having a sticky inflation, then obviously they are going to increase the interest rates.
Ryssdal: Seems to me, though, based on what you’ve said about uncertainty in the policies of the Trump administration, that a lot of the solution would be not having so much uncertainty.
Kalemli-Özcan: That’s right, that would be the solution. So that solution is better than the Fed’s solution because if the uncertainty really keeps feeding into these lower demand and lower investment plans and consumption plans — and that’s also what we are seeing in the stock market meltdown yesterday and today — then it is going to be a very difficult job for the Fed. They don’t want a recession. So if the recession now wins over inflation, that means they need to cut the rates. If you have both, or the stagflation scenario, stagflation is a very, very hard scenario for a central banker. And the solution here is really not the Fed, but it is not having these type of uncertain policies coming from the administration.
Ryssdal: With the understanding that things in an economy, to paraphrase here, happen very slowly and then all at once, we’re talking about stagflation now, and again, we are not there, but it could be here. How long do you suppose it’ll take?
Kalemli-Özcan: In terms of when are we going to see the recession and the higher prices, that is going to take time. Because remember, for actual higher inflation to be observed, the tariffs have to be in effect. It is just like all this talk creating this uncertainty. So if tariffs never really happen, but then, because now this uncertainty fed into the future plans of consumers and businesses, we might really end up with a recession.
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