Might this be the year that stagflation returns to the US? It has been half a century: The last time the US economy had both excessively high inflation and unduly high unemployment was in the mid-1970s, with inflation rates reaching 12.2% in 1974 and unemployment at 8.5% in 1975.
The new stagflation is unlikely to be as extreme as that. The latest inflation report came in at 3% for 2024, up from 2.4% in September. Still, there are few signs that the rate is falling. Recent data suggest that rents will increase at a modestly higher rate than in times past, and shelter costs account for about one-third of the consumer price index. Ongoing wage growth is another inflationary pressure.
Then there is President Donald Trump’s trade policy. It remains to be seen whether tariffs will prove durable, but current policy will probably lead to some retail price hikes. Even if most of the tariffs are removed or never instituted, manufacturers will think twice before building additional economic bridges to Canada and Mexico. Over the next few years, that will lead to higher costs and eventually higher prices.
Furthermore, the Federal Reserve cut interest rates by 25 basis points in December, a decision that now appears mistaken. That is more likely to incite than defuse inflationary pressures.
Of course, many of these problems predate the Trump administration, so even if Trump changes course on some policies, much of the basic momentum is already there. In any case, Trump’s current plans are not well suited to fighting stagflation. Kevin Hassett, one of Trump’s economic advisors, has suggested that the anti-inflation plan was lower aggregate demand and increased labor supply, but that is unlikely to succeed. The US already is close to full employment, and lower aggregate demand might spur or accelerate a recession.
And it gets tougher yet. Trump is a longstanding fan of low interest rates and easy money, for example, and one scenario is that he tries to impose his will on the Fed, leading to higher inflation rates. A more likely outcome, but still bad for the inflation rate, is that actual or threatened Trumpian interventions make the central bank more difficult to manage. That could limit the Fed’s ability to bring down the inflation rate in an orderly manner. Fed predictability and credibility are simply much harder to establish in the present environment.
