Economy: a surprise crisis raises fears of stagflation
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So much for the “Roaring Twenties,” Valentina Romei and Alan Smith said in the FinancialTimes. After nearly two years of rapid growth following initial shocks from pandemic shutdowns in 2020, the Commerce Department reported last week that the U.S. economy contracted sharply in the first three months of 2022, contracting at a annualized rate of 1.4%. Economists expected us not to match last year, when the economy grew 5.7%. But “the twin shocks of COVID-19 and Russia’s invasion of Ukraine” pushed inflation well above expectations, putting the United States and other economies at risk “from a painful mix of high prices and low growth known as ‘stagflation'”. employers forced to raise wages due to a tight labor market, inflation seems more likely to take hold. Most economic observers anticipated a strong 2022; instead, we ask ourselves, “How bad could this get?”
The number on the economy is not the whole story, said Neil Irwin in Axios. Trade deficits weigh heavily on GDP calculations because imports are subtracted from the overall figure. During the quarter, exports fell sharply due to weaker economic growth overseas, while imports soared, reflecting “an economy with significantly stronger domestic demand than the rest of the world” . Despite inflation, consumer spending remained strong – a positive sign of “the underlying growth of the US economy”.
Investors see no encouraging signs, Mohamed El-Erian said in the FinancialTimes. The S&P 500 fell 8.8% last month and is off to its worst start to the year since World War II. The Nasdaq fared even worse, falling 13.3%, and even traditional safe-haven government bonds tumbled. After two years of the Fed’s “turbocharging” of markets, investors finally accepted that “the central bank has no choice but to take its foot off the stimulus accelerator.” Amazon suffered its worst stock drop since 2006 after the e-commerce giant said it lost money in the first quarter and expects more losses to come, Matt Day said in Bloomberg. As an indicator of consumer spending, Amazon’s results are being watched “closely to see if shoppers will cut back on purchases to compensate for higher prices.” Demand “remains strong,” the company said, but not strong enough to sustain the “hiring and warehouse building frenzy” it has experienced during the pandemic.
This is not a 1970s redux, said Alan Blinder in The Wall Street Journal. When supply shocks caused inflation to spike and growth to slow in 1973, “no one knew how to think about it,” and the Fed’s hesitant responses reflected that ignorance. The lesson has been learned and economists “now understand that inflation and unemployment naturally rise or fall together when supply shocks rule.” The Fed “underestimated how long it would take for supply to catch up with rising demand,” and rates now need to rise significantly. But the economy remains “fundamentally sound”, with low unemployment and Americans sitting on excess savings that should cushion the blow of a slowdown. Any recession we get “shouldn’t be deep and long.”
This article first appeared in the latest issue of The week magazine. If you want to know more, you can try six risk-free issues of the magazine here.