As Night Follows Day, Stagflation Follows the 2020-21 Stimulus

Get your pins and t-shirts ready. This Thursday could be stagflation day.

On Wednesday afternoon, the Federal Open Market Committee will announce its rate decision. There are signs the central bank will hike rates by 0.75 percentage point, the second such move in just over a month. Inflation is at a 40-year high and the Fed’s move this week will show how desperate it is to restore price stability.

Eighteen hours later — on Thursday morning, as markets are still digesting the Fed’s move — the Commerce Department will release its first estimate of U.S. gross domestic product for the second quarter of 2022. There is more uncertainty surrounding this figure, but there is a good chance that the economy has essentially stalled in the first half of this year.

The timing will coincide pitifully, a rare moment in economic history, the economist’s equivalent of a solar eclipse: higher inflation, higher interest rates, slumping economic output.

The political danger to President Biden and the Democrats is so evident that the White House is already engaging in aggressive damage control. Their message is a familiar one, denial – only double this time: This is not a recession. And inflation is not our fault.

The first assertion is no more than a guess. The second is wrong.

Private sector economists’ estimates for Thursday’s second-quarter GDP growth numbers vary, but not by much. Recent polls of Wall Street economists suggest they are looking for an annualized rate between zero and 1%. The Federal Reserve Bank of Atlanta, which produces estimates of quarterly GDP growth in roughly real time, currently puts the figure at minus 1.6%.

The reason for the heightened interest is that if the Atlanta Fed is correct, this will be the second straight quarter of negative growth, traditionally the definition of a recession.

The White House is working hard to debunk the notion that a negative growth number means the US is in a recession. In an unusual statement late last week, its economists noted: “While some claim that two consecutive quarters of falling real GDP constitutes a recession, that is not the official definition, nor is it how economists assess the state of the business cycle.”

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As it happens, the President’s economists are right. The origin of the notion that a recession is defined by two consecutive quarters of falling production is unclear. My favorite theory is that the definition, in a nice bit of political symmetry for today, was invented by President Lyndon B. Johnson’s advisers to prove that after a string of bad economic news, the US was not in a recession.

The closest thing the US has to an official declaration of a recession is the result of deliberations by the National Bureau of Economic Research’s Business Cycle Dating Committee.

The NBER Dating Committee is not a matchmaking project for lonely macroeconomists. It is a bipartisan group of leading researchers who scour data to identify turning points in economic cycles. Fortunately for the White House, this is a lengthy process – initial data is frequently revised and updated. It typically takes about a year from the start of a recession for the NBER to tell us we’ve had one.

In 2000, it took the NBER 15 months to declare a recession, by which time the downturn was long over. That’s like having a doctor tell you that you’re officially ill a year after your funeral.

As the White House notes, the NBER examines monthly data for a range of economic variables and does not rely on the broad-based GDP number. That makes a lot of sense now. The post-pandemic economy is acting strangely. While production stagnates or declines, employment continues to grow strongly. (Even that could be a problem. It implies a sharp fall in labor productivity, which is not good for the economy’s productive potential.)

Therefore, we should indeed be careful when over-interpreting any set of quarterly GDP figures.

Even if the GDP figure should be positive on Thursday, the White House will not let it down.

For one thing, the first half of this year has been flat at best. But more importantly, the economy is battling headwinds from accelerating inflation. We are only at the beginning of a tightening of monetary policy, the effects of which have not even been felt yet – the first results will become apparent in the second half of this year. We don’t need an official committee of economists to tell us that inflation has been fueled by the reckless boost in domestic demand that the Biden administration and congressional Democrats gave theirs last year.

In all likelihood, the day of stagflation will only be the beginning.

Main Street: “Inflation is like alcoholism,” said economist Milton Friedman. “In either case… the good effects come first, the bad effects later.” Could there be a lesson for Joe Biden here? Images: Bettmann Archive/Getty Images Composite: Mark Kelly

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