Should Fed Be Concerned About Stagflation?

Thursday’s disappointing GDP report showing first quarter growth slowed to 3.1% ignited fears about the United States going into a period of stagflation similar to the 1970’s. Stagflation is a period of persistently rising prices during a time of slow economic growth. Inflation has risen during the first few months of the year in response to higher oil prices, but the slowdown in growth the United States is currently moving into would hardly be considered stagnant. Economic growth for the U.S. during the first quarter is right in line with historical averages.

A close look at the conditions currently impacting the U.S. economy finds no reason to believe that the Federal Reserve should be concerned with stagflation. The inflation we are currently seeing are a result of dramatic increases in commodity prices during initial phase of the current economic expansion. In the 1970’s, stagflation took hold as wages spiked in response to higher inflationary levels. The resulting increase in wages force companies to pass the higher costs onto consumers. Today, even with unemployment rates running below historical norms, workers are receiving minimal salary increases. The competitive nature of the current business environment prevents companies from granting employers higher wages in response to soaring gasoline prices.

We believe that inflation will moderate in the coming months as oil and commodity prices fall. As economic stimulus begins to wear off in the United States and growth returns to normal levels, inflation will begin to have a stronger effect on determining growth rates both domestically and abroad. Should inflation remain near 3% for a prolonged period, the loss of consumer purchasing power will begin to slowly erode economic growth. Additionally, with so many of the world’s economies relying on export growth, any slowdown in the United States would be felt globally. This scenario of a global slowdown appears to be unlikely. Financial Watch expects that economic growth will pickup in the second half of the year as inflation recedes to a more comfortable level.

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