Stagflation Threat: Inflation Accelerates While U.S. Economy Is Slowing Down

The U.S. overall consumer prices rose an unadjusted 4.2% in the year ended in May 2008. As expected, the largest contributor is increase in energy prices and food prices, which increased by 17.4% and 5.1% respectively from a year ago.

Core Inflation

Meanwhile “core” inflation has risen an unadjusted 2.3% over the last 12 months. The core inflation is increasingly seen as irrelevant. It measure inflation that excludes certain items which face volatile price movements and is most often calculated by taking the Consumer Price Index (CPI) and excluding certain items from the index, usually energy and food products as if their price increases are temporary. The core rate was introduced during the Nixon Administration, after the first oil shock

Import Inflation

Historically, recessions kill inflation because they hammer the job markets, depressing demand. This time the pressures are coming from outside the U.S. as global demand and prices are surging. The push is not only from oil, but also from a variety of commodities and other imports. Imports are already getting more expensive. Prices of imported raw materials, autos and other consumer goods are up. Weaker dollar pull further import prices.

The US overall Import Price Index rose 17.8% over the past 12 months ended in May, led by petroleum prices which were up 68.8% over the year. That was the biggest rise for petroleum import prices since an 82.5% rise for the year ending in February 2003. The cost of foreign goods excluding petroleum climbed at an annual rate of 6.6% in May, the fastest increase since 1990.

Global inflation has already hit a nine-year high of 4% annually, and it will rise further as the latest jump in oil prices works its way through world markets. Growth in emerging markets, fueled by booming domestic demand in China and hot Asian economies, is zipping along at about 7%. The high growth has been steamed from past easy monetary policies in emerging-market economies.

Stagflation Threat

The overall-inflation rate is dangerously high and the fastest pace since January. It indicates US economy could be afflicted with a stagflation, an expression generally used in the 1970s to describe the coexistence of high inflation and stagnant economic growth with high unemployment. Many economists have qualified their stagflation references in recent weeks with phrases such as mild stagflation, to differentiate current risks with the rampant inflation and high interest rate environment of the 1970s.

Inflation could play a big role in the economic growth outlook. Keeping inflation under wraps may require an extended period of weak growth. Lifting interest rates to fight inflation would risk extending the housing slump and the credit crunch, and it would lessen the chances for a solid recovery.

Chart: The Economist