Added 15 Days Ago

Following the hysterical herd has gotten us in this mess. Now is the time to try something else.

ew today will dispute that inflation is a serious problem. The latest CPI number, from April 2022, came in at 8.3 percent. Core inflation clocked in at 6.2 percent. Although slightly below the highs of March, the last time we saw inflation numbers like these was in the early 1980s.

What is even more shocking is that this inflation does not seem to be a simple case of economic overheating. In the first quarter of 2022, CPI averaged 8 percent and yet real GDP contracted by 1.4 percent. In basic macroeconomic theory, inflation is the result of too rapid growth in the economy. But if the economy is contracting at the same time as inflation is high, it is possible that the economy is slipping into stagflation.

Inflation versus Stagflation

Stagflation is a situation in which economic growth is low and inflation is high. It is the worst of all possible worlds. Income grows slowly, unemployment increases significantly (although we have yet to see this at the time of writing), and prices continue to rise. The last time we saw stagflation was in the 1970s.

Stagflation is also punishing for savers. In an inflation driven by high economic growth, firms earn more money as economic activity is high. This is reflected in the firms’ stock prices and dividend disbursements. Not so in a stagflation, in which markets tend to underperform and all wealth, asset and monetary, is eroded.

Normal inflation and stagflation have different causes. As we have already said, normal inflation is driven by too rapid economic growth. In economics-speak, we say that aggregate demand in the economy is outstripping aggregate supply. Think of aggregate supply as the total number of goods and services that are available for purchase by consumers and producers. Aggregate supply grows as firms invest in the economy. But there are limits on this growth. Aggregate demand, on the other hand, is the total amount of spending in the economy. There are no theoretical limits on the growth of aggregate demand. An increase in loans—public or private—can increase aggregate demand without increasing aggregate supply. This can lead to inflation.

Stagflation involves the supply side of the economy. In rare instances, we see a large amount of aggregate supply wiped out. One famous example of this is the case of Zimbabwe: After Robert Mugabe seized power, he expelled and harassed the white farmers. But when they left, he found that the black workers did not have management experience in running the farms. The result was a collapse in Zimbabwean food production and very high inflation.

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