The Inflation Genie and Looming Stagflation

By at 12 April, 2022, 10:21 am


by Raymond J. Keating –

As the old saying goes, once the inflation (i.e., an ongoing increase in the general price level) genie escapes from the bottle, it’s very difficult to get it back in.

That is clear in the latest Consumer Price Index report from U.S. Bureau Labor Statistics, which noted that inflation came in at red hot 1.2 percent in March. That extends a deeply troubling trend on inflation that really started at the beginning of 2021, with the March 2022 rate marking the quickest pace since September 2005.

Source: Federal Reserve Bank of St. Louis, FRED

Over the past year, CPI inflation ran at a scorching 8.5 percent.

The BLS pointed out that this was the “largest 12-month increase since the period ending December 1981.” Whenever you have to go back to the 1970s or very early 1980s to look for a similar inflation level, that’s never good.

Let’s do a quick reminder on some of the many ills of inflation.

● First, it is the reduction on the dollar’s purchasing power, that is, a dollar tomorrow will be worth less than today.

● Second, inflation, therefore, eats away at incomes, savings, etc., i.e., inflation is a kind of tax.

● Third, inflation creates uncertainty about where prices and interest rates are headed, making it hard for entrepreneurs, businesses and investors to plan.

● Fourth, costs increase for businesses of all types and sizes.

● Fifth, actual taxes increase, for example, since capital gains are not indexed for inflation, it turns out the real capital gains tax is much higher than the stated, nominal rate – and the higher the inflation rate, the higher the real capital gains tax. That serves as a disincentive for entrepreneurship and investment.

Obviously, the list of inflation ills is considerable.

But there’s more, unfortunately – stagflation.

The possibility of stagflation, that is, a recessionary or stagnating economy combined with high inflation, looms. Again, we must look back to the late 1970s and very early 1980s for such an egregious example of such an economic scenario.

How was stagflation beat last time around? A combination of tighter monetary policy and pro-growth tax and regulatory policies. That’s the policy combination needed today.

Source: Federal Reserve Bank of St. Louis, FRED

Instead, we’re getting treated to a Fed that has viewed inflation rather casually (the above chart showing the growth in the monetary base – i.e., currency in circulation plus bank reserves – does not show a Fed serious about price stability), and a White House and Congress bent on imposing additional tax and regulatory burdens on the backs of entrepreneurs, businesses and investors.

That’s a surefire way to increase the chances that stagflation will settle in for an unwelcome stay.

Raymond J. Keating is chief economist for the Small Business & Entrepreneurship Council.



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