By Martin Wolk Executive business editor
updated 4/22/2005 4:21:48 PM ET 2005-04-22T20:21:48

The word “stagflation” conjures up some pretty frightening memories. Long lines at gas stations. Unemployment over 10 percent. Double-digit mortgage rates.

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So let’s specify at the start that what is going on in the economy right now is nothing like your father’s stagflation — a nasty combination of hyperinflation, high unemployment and persistently sluggish growth that foiled policy-makers a generation ago. (Remember President Ford’s ineffective “Whip Inflation Now” buttons?)

Still, economic growth is clearly slowing at the same time inflation is rising, an unpleasant alignment of factors that could pose a tough puzzle for the Federal Reserve in the near future as central bankers consider whether to continue raising interest rates.

Princeton economist Paul Krugman wrote in his New York Times column this week that stagflation fears were behind last week’s sharp drop in stock prices, which was partly reversed in a big rebound Thursday.

“What few seem to have noticed, however, is that a mild form of stagflation — rising inflation in an economy still well short of full employment — has already arrived,” he wrote. Other economists took issue with the description, noting that the term stagflation was coined to describe far different conditions.

"Given where growth is and where growth forecasts are, I don’t think stagflation can seriously be considered an issue,” said Drew Matus, a financial market economist with Lehman Bros.

"To get into a stagflation regime you would have to have inflation expectations unhinged, and we definitely don’t have that,” said Sheryl King, senior economist at Merrill Lynch. “Inflation expectations are anchored right where they have been for the past five years.”

Other analysts said the murmuring about stagflation reflects uncertainty about an economic recovery that often has been felt more strongly in corporate profits reported on Wall Street than in wage gains enjoyed on Main Street.

"There always seems to be another shoe to drop,” said Jared Bernstein, senior economist for the Economic Policy Institute, a liberal think tank in Washington. He pointed to the “jobless recovery” of 2002 and 2003, which was followed by last year’s summer “soft patch,” concerns about U.S. structural imbalances and worries about another oil-induced soft patch. “I think what is weighing down financial markets now is this recovery has never really found its legs.”

Bernstein pointed out that wages for blue-collar and other non-managerial workers have failed to keep up with inflation over the past four years since latest recession began. Hourly wages, covering about 80 percent of the work force, have dropped about 0.5 percent over the past year when adjusted for rising prices.

“Stagflation is too strong a word, because it connotes very weak growth and very strong inflation,” said Mark Zandi, chief economist of, a forecasting firm based in West Chester, Pa. But he referred to a “stagflation-type” atmosphere in which higher energy prices appear to be chilling the economy even as the Fed is battling a steady upward creep in inflation.

A hint that the economy may be slowing sooner than expected came last week in a report of disappointing March retail sales . And this week's inflation news appeared to show that rising oil prices are being felt broadly in the economy.

Larry Horwitz, senior economist at Decision Economics in Boston, also said he is worried about the possibility of a “stagflation-like” environment that would make life difficult for the Fed in the final months of Chairman Alan Greenspan’s long tenure.

“It’s not all that far away,” he said. Horwitz said he would be worried if core inflation rises beyond 3 percent from its current 2.3 percent, and growth dips below 2.5 percent from its current level of about 3.5 percent.

That would create a “classic squeeze” on the Fed, “where they are damned if they do and damned if they don’t,  trying to get inflation not to rev up without killing the economy.”

He estimated there is about a 15 percent chance such conditions will emerge, meaning he is fairly confident the Fed will be able to keep a lid on inflation without choking off growth.

For his part, Fed Chairman Alan Greenspan categorically dismissed concerns about stagflation in response to a question Thursday from a member of the Senate Budget Committee. He and other Fed officials have expressed far more concern about long-term structural problems stemming from the twin U.S. budget and trade deficits.

“It is worth noting that these sorts of imbalances are not new,” Fed Gov. Donald Kohn said in a speech Friday. “But the magnitude of these imbalances is increasingly moving into unfamiliar territory.”

He said the Fed intends to continue raising interest rates, in part to dampen the “upward momentum in housing prices” and encourage Americans to increase their personal savings.

And Kohn warned of potentially sudden changes in asset prices, much like the tech-stock bubble that collapsed in 2000. “Although the odds seem favorable for an orderly adjustment, the current imbalances are large and — importantly for gauging risks — unusual from a historical perspective,” Kohn said.

His comments echoed a warning recently issued by former Fed Chairman Paul Volcker, who warned that record trade deficits mean “we are skating on increasingly thin ice.”

The near-term threat from stagflation seems remote compared with what could happen if, for example, China were to substantially reduce its purchase of dollar-denominated assets, causing a sharp decline in the dollar and corresponding increase in interest rates.

“I think the U.S. economy is really kind of fragile,” said Paul Kasriel, director of economic research at Northern Trust Co. “If interest rates were to spike up like they did in the ‘70s, we would see the U.S. economy crumble.”

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