According to former President Barack Obama’s chief economic adviser, the risk of the US economy returning to a 1970s-style stagflation scenario is at its highest in decades.
Jason Furman, a Harvard University professor who previously chaired the Council of Economic Advisers, warned that an aggressive Federal Reserve, rising interest rates and persistently high inflation have raised the possibility of a period of stagnant economic growth and high consumer prices.
“It’s a real risk,” Furman said in an interview with FOX Business. “It’s the biggest risk of stagflation in a long time. But it is no guarantee that the economy will fall into recession. Consumers still have plenty of money. You’re still spending. So there is still some hope for the US economy.”
Stagnation is the combination of slowing economic growth and high inflation, characterized by rising consumer prices and high unemployment. The phenomenon devastated the US economy in the 1970s and early 1980s, as rising oil prices, soaring unemployment and loose monetary policy pushed the consumer price index as high as 14.8% in 1980 and forced Fed policymakers to raise interest rates to almost 20% increase.
The Fed is raising interest rates by 75 basis points in a historic move to fight inflation
Inflation accelerated again in May, the government said earlier this month consumer price index, rose 8.6%, much higher than economists were expecting. It marks the fastest pace of inflation since December 1981 and underscores how strong inflationary pressures remain in the economy.
Scorching hot inflation has created severe financial pressures for most US householdswho are forced to pay more for necessities like food, gas and rent. The burden will be borne disproportionately by low-income Americans, whose already stretched paychecks are severely affected by price swings.
The stock market has also suffered amid rising inflation and interest rate hikes, with the S&P 500 down 20% this year.
As a result, the Federal Reserve is moving at its fastest pace in decades to tame consumer demand and bring inflation closer to its 2% target. Just last week, policymakers voted to raise interest rates by 75 basis points for the first time since 1994. The move put the federal funds rate between 1.50% and 1.75%, the highest since the pandemic began two years ago.
However, the Fed’s policy of curbing consumer demand and taming inflation is expected to slow the economy, with a growing number of Wall Street firms are forecasting a recession in the next two years. Goldman Sachs, Bank of America and Deutsche Bank have all raised the likelihood of a downturn in 2022 or 2023, and Fed Chair Jerome Powell has acknowledged that there is a real possibility of a recession.
“It’s certainly a possibility,” Powell told lawmakers Wednesday. “We’re not trying to provoke and we don’t think we need to provoke a recession, but we think it’s absolutely necessary that we restore price stability, really for the good of the labor market, as much as anything else.”
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Rising interest rates tend to result in higher interest rates on consumer and business loans, which slows the economy by forcing employers to cut spending. Mortgage rates are already approaching 6%, the highest level since 2008, while some credit card issuers have hiked rates to 20%.
Furman said he expects central bankers to end the year with interest rates near 4% as they try to catch inflation. But consumers shouldn’t expect prices to fall immediately, he said.
“It will take a while for inflation to come down,” he said. “I think inflation will be high all year and maybe some things will fall. Maybe car prices will fall. At some point, gas prices will fall. We’ve had oil prices starting to fall gasoline. But if you’re asking about average prices overall, it can take time.”
Rampant inflation has become a major political burden for President Biden ahead of the November midterm elections, in which Democrats are expected to lose their already razor-thin majorities. Polls show that Americans see inflation as the country’s biggest problem. And many households blame Biden for the price spikes.
In response, the President has floated the possibility of temporarily suspending the 18.4-cent-a-gallon gasoline tax, a move that would require action by Congress. It’s designed to help consumers cope with higher prices at the pump in the face of a record rise in fuel costs, but Furman slammed the proposal as a “gimmick” that will do little to line households’ pockets and instead bring a big windfall would oil companies.
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“Most of this is the Federal Reserve’s job of containing inflation,” Furman said. He suggested the White House could instead consider smaller strategies like reducing the federal deficit, removing tariffs, making the shipping industry more efficient or making it easier to get a truck driver’s license to ease supply chain disruptions .
“Lots of little guidelines you can follow,” he said. “But the big tools, that’s all in the hands of the Federal Reserve.”