If you watch CNBC, read The Wall Street Journal or scroll the internet you have come across the term stagflation.
Stagflation is an economic condition characterized by persistent inflation, increasing unemployment, and slow economic growth all occurring simultaneously. The term itself is a blend of stagnation and inflation.
Because stagflation presents challenges to the economy from multiple angles, addressing it can be difficult.
When it comes to Federal Reserve monetary policy, many of us understand the simplified version: The Federal Reserve lowers interest rates to stimulate economic growth, and it raises interest rates to slow it down. In its simplest form, “the Fed” is increasing demand or discouraging it.
Behind the scenes, looser monetary policy stimulates economic growth by making borrowing easier, resulting in increased spending, and ultimately creating jobs. However, this often leads to higher prices for goods and services, sparking inflationary pressures.
Conversely, tighter monetary policy is designed to slow the economy by contracting the job market. Typically, borrowing becomes more difficult as lenders pull back, and as a result discretionary spending shrinks. Economic slowdowns typically help ease inflationary pressures by reducing overall demand. However, if a tight policy remains in place for too long, it can tip the economy into a recession.
The economy is not mechanical. It’s very nuanced—not all of its “moving parts” are controllable or manipulable, and they don’t react in real time.
Stagflation disrupts the traditional “Fed” economic playbook by combining sticky inflation with slowing economic growth and a weakening job market.
In a stagflation scenario, the Federal Reserve faces a difficult dilemma. If it raises interest rates to curb inflation, it risks further harming an already struggling job market and slowing economy. On the other hand, if it lowers interest rates to stimulate growth and employment, it may worsen existing inflationary pressures.
The causes of stagflation vary and don’t always stem from the same factors. The U.S. economy is vast and complex, with changes in one area creating ripple effects that can impact other sectors in surprising and often unpredictable ways.
Presently, we do not anticipate the United States falling into a period of stagflation.
Presently, unemployment remains historically low (for reference the 25-year average is closer to 5.2% than the current 4.1%).
(1) Additionally, near-term economic weakness could aid the Federal Reserve in its nearly four-year battle against inflation. Once inflation falls within the Fed’s target range, Fed officials will have room to cut the Federal Funds Rate (FFR) multiple times in 2025, helping to revive economic growth.
At WT Wealth Management, we believe that a series of rate cuts resulting from an economic slowdown could enable the U.S. to achieve a future of sustained moderate economic growth, low unemployment all while maintaining more stable consumer prices than we have experienced over the last several years.
SOURCES
- Unemployment Rate - 20 Yrs. & over
FRED | St. Louis Fed
*Grammar, spelling and some formatting provided by ChatGPT
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