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The S-Word
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Sun Jul 27 22:41:01 2008
 
The S-Word
 Stagflation is back...


Welcome back, Carter: it's the 1970s again!
Image courtesy of Tom (wiki)
 
In The Great Stagflation of 2008 I talked about the coming of stagflation.  
 
Well, now I know it's here! How do I know?  
 
I know because the Federal Reserve is now denying we are experiencing stagflation, which is a pretty sure sign that we are.  
 
What is stagflation? It is when an economy is hit with slow growth (or contraction) and rising prices.  
 
The combination presents a problem for policy makers. What do you do?  
 
If you lower interest rates to spur growth, then you stoke inflation that just causes prices to go up more. And sometimes the higher prices cut into growth again. So cutting rates just causes inflation without growth.  
 
But if you raise rates to stop inflation (price increases), then you hurt growth because it's harder for companies to find the cash they need to expand.  
 
So now the Federal Reserve is wringing its hands about what to do.  
 
Fortunately, the answer is simple: raise interest rates.  
 
Why do I say that? Because the Fed's main job is to protect us from inflation. If inflation gets out of control, it destroys peoples' savings, and that can have catastrophic consequences.  
 
Besides, the Federal Reserve isn't really supposed to be the safeguard of the US Economy: that's the Federal Government's job. The Federal Reserve should just be safeguarding the currency.  
 
What do I think will happen? Given the recent track record, I have a pessimistic outlook. I think the Federal Reserve will continue to drift for a while, and attempt to be all things to all people as it deals with the current recession. One example is its disastrous decision to insure investment banks, which is going to cost us all a lot of money in a few years. (Incidentally, that is a fairly biased article, but worth reading for the viewpoint).  
 
We will need to hope that the Executive or Legislative branches will eventually decide to sort things out without damaging the currency.  

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