The US economy is at a mounting risk of spiraling into a 1970s-style stagflation crisis as the Russia-Ukraine war exacerbates already sky-high inflation, according to a new analysis.
The Economist Intelligence Unit, in a Thursday note, predicted that consumer prices will continue to hover near a 40-year-high “at least until the middle of the year,” weighing on consumer spending and real GDP growth. The London-based group already lowered its forecast for US GDP this year from 3.4% to 3%.
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Combined with an increasingly aggressive Federal Reserve, which lifted interest rates by a quarter-point in March and signaled at least six more, similarly sized increases this year, and the fallout from the Ukraine invasion, the outlook for the US economy is growing bleaker.
“The economic fallout from the war and other external factors, such as the emergence of a new coronavirus variant (which remains our baseline scenario), expose the US to the growing risk of stagflation – low growth combined with high inflation,” the analysis said .
Stagflation is the combination of economic stagnation and high inflation, characterized by soaring consumer prices as well as high unemployment. The phenomenon ravaged the US economy in the 1970s and early 1980s, as spiking oil prices, rising unemployment and easy monetary policy pushed the consumer price index as high as 14.8% in 1980, forcing Fed policymakers to raise interest rates to nearly 20% that year .
A telltale sign, and consequence, of stagflation is rising energy prices, according to many economists, who believe it occurs when a sudden increase in the cost of oil reduces an economy’s productive capacity. For instance, in 1973, the Organization of Petroleum Exporting Countries imposed an embargo on oil supplies to the US over its support for Israel.
There are other economists who believe the US economy is showcasing signs of stagflation today, as the Russian invasion of Ukraine sent oil prices soaring. Crude prices were steady on Friday and were poised to fall slightly as countries announced plans to release supplies from their stockpiles.
Consumer prices already jumped 7.9% in February, just as the war in Europe began, and are expected to remain elevated in the coming months.
Danielle DiMartino Booth, the CEO and chief strategist of Quill Intelligence and a former adviser to a Dallas Fed president, said stagflation “appears to be an imminent development.” She cited dwindling economic growth forecasts for the first quarter as well as inflation for energy and food that is double what it was in the 1970s.
“Rather than having the ability to ease monetary policy into a slowing economy, the Fed is embarking on a tightening campaign,” she said.
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Central bank policymakers have signaled in the weeks since their March meeting that they could raise interest rates by 50 basis points in future meetings and start reducing its massive balance sheet at a pace of $ 95 billion a month as it seeks to cool the hottest inflation in four decades.
Minutes from the US central bank’s March 15-16 meeting released on Wednesday show that “many” policymakers would have preferred a larger rate increase last month but determined that a more modest quarter-point hike would be appropriate “in light of greater near-term uncertainty associated with Russia’s invasion of Ukraine. “
“Many participants noted that one or more [half-percentage-point] increases in the target range could be appropriate at future meetings, particularly if inflation pressures remained elevated or intensified, “the minutes said.