What is stagflation?

When high inflation, slow growth and high employment combine, they result in an unfortunate economic situation known as stagflation. But what exactly is stagflation, and how does it work? Most importantly, how can we prevent it in the future?

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Episode Transcript

Speaker 1 (00:00):
Brought to you by the reinvented two thousand twelve camera.
It's ready. Are you welcome to Stuff You Should Know
from house Stuff Works dot Com. Hey, and welcome to
the podcast. I'm Josh Clark, There's Charles W. Chuck Bryant,
and this is Stuff you Should Know the podcast. Um,

(00:24):
and we are going to be talking today about econ
one oh one. That's right, this is Chuck's favorite subject.
I think this in UM physics. I know, I know
why I hate econ boy, because I just money. I
hate money, and some tough economists beat you up on No,

(00:45):
just money, the whole thing. Like Emily pays all our bills.
I can't even if I had to do that. You said,
she's the CFO, right, Yeah, if I had to be
the CFO, then we'd be in big trouble. Yeah, because
I just don't like it. I don't like anything about it. Well,
this is more UM, less household economics, more macro economics. Yeah,
this is interesting. I thought this is there. There's a

(01:06):
historical battle involved the seventies. People in Bell Bottoms, probably Um,
Ronald Reagan, everybody. That's the whole cast of characters. Let's
do it well, Chuck. I was reading an article UM
as is my Way, UM about rampant inflation in two

(01:28):
thousand eleven. YEA. And basically, this guy named Michael Snyder
UM was is warning that we're going to see, I think,
as he puts, an inflation that we've never seen before
in the US. And inflation is this huge boogeyman where
money buys less because prices rise. And there's all sorts

(01:53):
of reasons that comes about, but one of the one
of the if you look at classic economics, the reason
why inflation tends to happen is that there's too much
of something, right, the old supply demand right. You have
in this case, too much money on the market. Therefore,
since money is subject to supply demand, more money there

(02:13):
is on the market, the cheaper it is because there's
more of it, demand goes down, prices go up, right
for the cost of goods exactly, and you have inflation.
What this guy's warning about is that UM airline fares
for the past holiday season were thirty percent more than
they were the year before. H price of food has

(02:36):
been increasing, UM. There's been double digit health insurance premium
race races. I haven't noticed. I don't think that that
has anything to do with inflation. I think that's just
the insurance companies punishing the USA UM. He also he
gives some other steps cotton increased, beef up, pork up

(02:58):
sixty percent, hides or ups you know that run for
the hills. Hides are up. UM and food prices especially
are kind of a problem when inflation occurs because you
need food to eat. That's very sensitive. And the USDA
released their figure saying basically like, yes, porks can arise,

(03:20):
some beefs can arise some, but overall the food cost
inflation is going to be like one percent, which is
definitely doable. If you look at the government statistics, right,
our inflation is pretty much at zero maybe one percent,
which now, yeah, which is actually less than healthy. You
want things to increase, you want inflation to take place,
but you wanted to plod along at a very slow,

(03:43):
steady rate. Inflation is the reason why up to say
two thousand and seven, house grew in value over thirty
years thanks to inflation. You paid X number of dollars
for it, and it increased in value in large part
because inflation. So inflation is good as long as the
center control hyperinflation is really bad. The worst thing of all, though,

(04:04):
is stag inflation. And if inflation happens right now, we
are a prime in a in a prime seat for
stag inflation, which would be very, very bad. Do you
want to tell everybody what stag inflation? Can? I give
a couple of stats because he's one form later on
when when we're talking about inflation, h July two thousand
eight is when it peaked in the last let's just

(04:26):
say decade inflation. Yeah, July two thousand eight, it peaked
at five point six percent, So keep that number in mind. Okay,
I'm gonna write it down. And December of last year,
so just a couple of short months ago, it was
about one point five and the average for two thousand
nine was negative point three. It's a negative percentage in

(04:48):
two thousand nine. And there's something to be said about
deflation as well, because that money that you do have,
if you have any, becomes much more valuable. That's right.
So keep those numbers in mind as as we proceed here.
Uh down point point three four, negative point three four
in two thousand nine, and we peaked in two thousand
eight five, which was a staggering number I got him

(05:11):
compared to like everybody. You can ask me if you
need a reminder later on. So, stagflation, Josh, is not
something that we made up, even though I thought it
was something you made up. It describes a really bad,
perfect storm of economic news. It's when you have high unemployment, right,
slow growth coupled with high inflation. And this is something

(05:32):
that people didn't think was possible. No, and and let's
let's describe that. Let's point that out. Where we are
right now. We have very high unemployment I think it's
at ten percent nationally, pretty much getting better. Slow economic growth,
for sure. We're in a recession, after all, still crawling
out of it, trying to at least, Right, we're in
a basically a stagnant economy, which means it's it's growing
very sluggishly or not growing at all. Yes, but our

(05:55):
inflation is is pretty good, right, thankfully. But since we
have those other two I said, we're in a prime
spot for if inflation does come along, We're in a
prime spot for stag inflation. The reason stag inflation is
so insidious, Chuck, is because it forms a vicious cycle. Right,
So you've got um you have high prices because of inflation,

(06:19):
which means that people can't spend as much money, or
when they do spend money, it doesn't buy as much.
Your dollars shrinking essentially. Okay, so you have a shrinking dollar.
You know, high unemployment, which means people have less money
to spend, right in, Your savings aren't worth as much,
right which ultimately leads to a sluggish economy. So there's

(06:39):
no way to to for this thing to naturally cycle
out of it like this could keep going indefinitely, this
horrible plodding along what I think Carter called malaise. What
he said, I think so I believe it uh economic
slow down as normal people don't. You know, a lot
of people freaked out with the recession, but people really

(07:00):
he knew about it. Economics said, recessions are kind of
what corrects it in the end, exactly we've talked about,
so don't freak out too much in our in our audiobook, Yeah,
we talked about how if you look at the economy
is made up of like a forest. There's a big, heavy,
huge trees which represent really well managed businesses, and then
you've got the underbrush which are just kind of add ons.

(07:21):
They're they're artificial almost they they shouldn't necessarily be there.
They're kind of sucking off of the bubble speculation and
artificially inflated economy. Right, and then when the wildfire comes along,
which is the recession, the underbrush is burned away and
things correct themselves. Sure, it's a pretty um dehumanizing way

(07:45):
of looking at things, but so is economics. You're right. Uh,
And part of the seventies people didn't think this was
possible because of our friend Mr Kane's John and Inner
Kines with stagflation. Yeah, it wasn't even a word before
the seventies. Yeah, well we should point out to it.
It's a contraction of stagnant and inflation. If you didn't
figure that out, So there that is. Did somebody thought

(08:05):
a stagged party and inflation? Really? Oh well, a lot
of people thought bartering was bartending. I noticed that that.
We got a lot of suggestions for bartending podcasts, and
all of a sudden, after the bartering podcast, people got
their whistle wet. So if you're canes I in in
your economic theory, you're gonna favor supply and demand and

(08:29):
you're gonna think that's pretty much what it's all about.
Demand is high. You got a booming economy, prices are
going to go up. Inflation is gonna rise some in
relation to uh, the economy rising. Right. What what you're
talking about is the Phillips curve, right, yeah? Is that
was was that the Phillips curve? Yeah, So that the
X axis of the Phillips curve is unemployment, yes, and

(08:52):
then the y axis is inflation, right, yeah, And that
happened from about fifty eight to seventy three post war boom,
things were rising in that in sort of a not
a wonder one ratio, but it even happened before then,
Like the Phillips curve is is vetted that that it
is correct. Basically, as unemployment rises, inflation goes down naturally,

(09:16):
and if you have low unemployment, inflation rises if the
converse is true, supposedly right, And the reason why is
because when unemployments high, demand is low, therefore inflation is down.
Prices are low, so inflation is down. And historically this
this holds up if you go back and chart all

(09:38):
this up to the seventies, this is this was the case,
and that's how it is naturally. The problem is the
FED in the sixties thought, well, if we just keep
unemployment artificially low, will trade that off for slightly higher inflation.
But we can keep on top of that so we
can expect high inflation and act accordingly, but we'll have

(10:00):
artificially low unemployment or near full employment, which is where
everybody's employing. Yeah. They basically thought the rate of inflation
would rise in a safe manner that they could keep
up with. Yes, do you remember I don't know if
I've used this before, but do you remember um that
Simpsons where Homer brings home Pinty the lobster. Have I
used this one before and puts Pinchy in the fish

(10:21):
tank And Pinching needs salt water, but the goldfish needs freshwater,
so it keeps adding salt and then like regular water
until they're both like half floating in the middle of
trying to balance it, and you end up killing both. Right.
But that's kind of what you have to do if
you're going to get in and regulate the economy, if
you're not just going to let it do its own thing,
you have that's the that's the trick you have to

(10:43):
do to keep a scary job. Oh yeah, it's gotta
be terrifying. Imagine the pressure that like Bernanke and those
who preceded him are under, because I mean, history will
make a villain or a monster or a hero out
of you depending on what you do. You're not going
to just do nothing. It's you're going to leave an
impression on depending on what you did. Like, you can't

(11:04):
go in and lead the FED and be like, I'm
not doing anything. You know, it's two thumbs and wouldn't
want that job. This guy right here. So you said
they got it wrong, Yeah, they got the Philip they
got their interpretation of the Phillips curb wrong. Yeah, and
what that produced is called a wage price spiral. And
we can get into more detail, but the long and
short of it is that inflation rows faster than wages.

(11:27):
Did you want to know how let's hear it. Well,
this is this is what basically bucked the Phillips curve.
Is that through government spending, like the government can spend
on uh, infrastructure, the public sector to create jobs right
through government spending UM and through you know tax policy

(11:50):
that that forms UM the way the government can create
or manipulate aggregate demand. Okay, I's say for example, you
keep taxes low and you increase consumer spending, you can
kick start an economy. Right. Um, you keep unemployment low,
you trade off for a higher rate of inflation, like
we saw they did. That's fine, that can conceivably work.

(12:12):
The problem is they put too much money into an economy,
kept pumping money into the economy no matter what. And
what they found was, like you said, the wage price spiral,
and basically it's where prices rise. So the the they
the fed, new that inflation was going to happen. But
when inflation happens, prices rise. When labor is sitting there

(12:32):
working their tail off and prices are rising, they make
the assumption that that means that industry, their bosses, their
employers are making gobs of cash. Well, labor says, we
want some of that cash, so give us more, give
us higher wages, which they did to a certain degree,
but they couldn't keep up. But the problem with that
if you're if you're captain of industry, is that if

(12:56):
you pay more, that raises your cost of product, which
means that you have to raise the price, which means
that your employees need more money because of inflation, and
it creates this again another vicious cycle, and that's the
wage price spiral. It spirals upward and um basically eventually
employers stop increasing wages and inflation just takes off. And

(13:19):
we might have survived that Josh in the seventies, as
bad as it was, we might have eked through if
it were not for the oil embargo of nineteen seventy three.
When everyone knows oil went through the roof, and that's
not just uh, you know Sally at the gas pomp,
that's across all industry, and it the that coupled with
everything else going on, all of a sudden. In nineteen seventy,

(13:43):
inflation was at five point five percent, which in July
tw two thousand eight, I said it was five point six.
So in nineteen seventy they thought it was high at
five point five, seventy four, twelve point two, and then
it peaked at thirteen point three percent in nineteen s
and again most economists agree that you want an economy

(14:03):
that's inflating in about two percent a year. This is yeah,
I mean into July two thousand eight at five point
six percent, people were freaking and imagine thirteen point three percent.
So basically Carter's just standing around, just getting it from
all sides. He's got hostages in a ran that he
can't get get um released. Um, he's got malaise forever.

(14:26):
You got stock market that basically stopped working, right, he's
got brownouts and lines of the gas pump, and yeah,
he's got an economy that's um and out of control
of inflation. He has no idea what to do. Right,
then insteps. This guy named Paul Volker cannot throw in
one more stat Uh talked about the stock market. From

(14:47):
seventy to seventy nine, the SMP five returned an average
of five point nine percent annually. But when you've got UH,
the inflation that you subtract, you're actually losing money. The
entire market is losing money two point six per center, right,
two point six percentage points lower than inflation. So basically
everybody's throwing in on the stock market during that time

(15:07):
was paying two point six percent in losses. Not good, No,
that's very bad, especially couple with inflation. People like you said,
we're freaking out right, So bring us on to the
savior of sorts. So Paul Vulker comes along, and you
might recognize that named chuck. He's an economic advisor to Obama,
but he got his chops as the head of the FED. UM.

(15:32):
And in nineteen seventy nine he basically says, Okay, Kensian
liberal monetary policy is is done. It's failing us, or
we're falling apart right now. We have to try something else.
And basically what they tried was the stuff that was created.
It's it's called neoliberalism. Is created by a guy named

(15:52):
Milton Friedman. Yes, and his basic formula was, quote too
much money chasing too few goods. So the Fed's free
up too much money to circulate in the economy, and
that's not a good thing. Right. So everything we see
the FED doing now is based on Freedman's economic policies. Right. Um,

(16:13):
Remember we said that um with with the FED in
the sixties and then the seventies. Um that their whole
thing was throw more money at it because that will
increase spending, which will increase demand, and yetta, yetta, everything
will be fine in the midst of this emergency. The
what's considered the fatal flaw they made was that rather

(16:33):
than start sucking up some of this money to make
it more scarce, and two Hens make it more valuable. UM,
they they pump more money into it. Well, Vulker comes along,
using Freedman's ideas and says, we gotta get some money
off of the market, so we're gonna start buying it up.
And what they did was they started issuing treasury bonds.
They sold t bills. That's how the government issues and

(16:57):
UM and purchases debt, and that's how they control the
amount of money on the market. You know that. Yeah,
that's Freedman's ideas. So when the economy is good, they're
gonna raise interest rates to slow down the flow of
money basically, yeah, because bubbles no better than a recession. Yeah,
and the same in reverse. When the economy is tanking,
they're gonna lower the interest rate and say, hey, go

(17:18):
out by house because look how it is exactly which
is exactly what they're doing right now, what we're seeing
right now. It was started in nineteen seventy nine, and
it didn't really exist, at least in practice in the
United States before then. Apparently Freedman and his UM people
tested out these theories. Is neoliberalism with UM in Chile
when Augusto Pinochet with US back c I A coup

(17:43):
um took over the Freedman's Chicago School. People went down
there were like, hey, let us help you set up
this new economy. Yeah, that's what happened in Iraq. Apparently
it was designed to figure out how to get the
u S mits in other entries coffers by setting up
an economy that was very friendly to capitalism. It's it

(18:06):
happens here now too. One of the results of it, Chuck,
is when you cut off the flow of money. And
this was the reason why they didn't why the the
FED in the sixties and seventies didn't think to do this.
When you cut off the flow of money, that means
companies have less money. Right, demand goes down and people
get laid off. So, since the focus of the FED

(18:28):
during the post war boom and up into the late
seventies was to keep unemployment as low as possible, it
was all on jobs. At the time, the way Freeman
looked at it was the opposite, like, no, you don't
focus on that. You focus on keeping the economy growing
in a manageable pace. Maybe don't worry quite so much
about unemployment. As a result of that, you took off money,

(18:49):
unemployment goes up. So inflation and in fact is what
the current standards think controls the economy more so than
the joblessness rate. Right. Interesting, Well, there's less uh focus
on on although it is a factor and a cause
for concern. It's anything like it was as far as
Fed monetary policy went in the sixties. The thing is,

(19:11):
Freedman gets tons Freedman and Vulcar get tons of credit.
But they fix the economy by kicking in like basically
kickstarting a recession. Yeah, and the recession was painful, but
then inflation stabilized, so it does work. But you're gonna
have to go through an impression and a recession. Well yeah.
And the trick is is the Fed has to predict

(19:33):
the short term and the long term and they have
to identify when that where that exact point is, or
maybe not exact, but get pretty close when they need
to start controlling that money flow again and the interest rates,
and good lord, it's on the hands of a few,
it isn't it. Right, Well, if you if you raise
interest rates too early, um, what you're going to do

(19:54):
is stop borrow when you're gonna stop growth. Right, So
if you're if you're economy hasn't really been kickstarted, is
on its own. Um, then you're gonna you're gonna push
it right back into a reception, a double difference session. Right. Um,
if you wait too long, then there's gonna be too
much money on the market, which is what that guy
I was talking about at the beginning is worried about

(20:16):
that there's a lot of money and like cash reserves
and banks and people hoarding it. But once it eventually
hits the market, our inflation is going to just go
through the roof. You worried about stagflation as you think
it's common. He's worried about inflation. And if if, if
we remain in these factors, then I'm saying that would
cause stag inflation. But um, I guess I got one

(20:37):
last thing. What you got? The irony of Freedman's success
proves the Phillips curve works. Yeah. When he when his
policies carried out by Vulker kicked in, unemployment, unemployment rose,
inflation went down. Yeah, you're right. Yeah, I've never felt
so helpless in my life. Yeah, we're we're in trouble.

(20:58):
We're just as small but small little pieces in this
whole puzzle. Yeah we are. Um, that's why they call
it macro economics. And that's why you're concerned with microeconomics
because you love your CFO exactly the end and my
house right just reset lower, So I'm all, I'm all
happy right now, I said the end? Oh sorry, Uh.

(21:19):
If you want to learn more about stag inflation, um,
can I borrow some money? Then chuck? No, because that's
going to be used to paid on other debt. It's
all a big visious cycle like we thought. Oh well,
while we're on it, while are you talking about debt?
Um f y I if you have fixed debt? Right? Yeah, Um,
let's say you owe somebody twelve dollars. Best time to
owe to pay that that money off is when inflation

(21:41):
is high, money is cheap and abundant. Good point. Yeah,
it's best to save when money is cheap or whey
is expensive. Right, all right, So that's it, right, Truer
words have never been spoken, that is it. If you
want to learn more about stag inflation and see a
really sad line of nineteen eighties auto workers in Detroit,

(22:03):
you can type in stagflation in the search bart how
stuff works dot com, And as always, we encourage you
to read all of our economics articles because they are fascinating,
I said, search bar right. Well, that means it's time
for a listener mail. Hey guys, how this is from
Jason How Hey guys, how's it going? I hope all
as well? Catching up on the podcast and Chuck mentioned

(22:25):
that he had a big wheel but wanted a green machine. Well,
my first memory actually is of a green machine. My
friend Boomer got one, and my mom Dot who was
the greatest mother ever by the way, uh and I
lived in an apartment complex. She was sitting on the
bench outside with her neighbor and I went to the
top of the hill to try this green machine. Out.
Came down as fast as I could, because that's what

(22:46):
you do, and uh I could Uh. I figured I
would skid right out in front of the bench. I
was going very fast though, pulled the handbrake the last second,
and the handbrake came off completely in my hand, and
I remember thinking, Uh. Then I was in my neighbor's
arms running for the car as I crashed into the bench,
busted my face and I wide open. At the hospital

(23:07):
they had to put me in a straight jacket in
order to stitch up my face, he's freaking out. I
guess so. My eye was stuck shut for a few weeks.
And my very next memory is the night my eye opened.
I was at my grandmother sisters house. He's either talking
about his great aunt or his grandmother was named. Says okay, okay.

(23:29):
When it opened, I was really excited. I showed my grandmother.
She told me to shut his tic Tac dough was on.
Remember that show. I love that show, l O L.
He says, these moments made me laugh so hard. Thank you,
Chuck and Josh. We're talking about the green machine and
letting me reminisce. It's from Jason in Baltimore, Maryland. Wait
to talk about the green machine, Chuck, it was the best.

(23:51):
It's good news. I bet you could find those on
the on the eBay. They'll cost you some money maybe.
So if you've got okay enough and do you have one? Oh,
I don't know, Jerry got my green machine? How about
if you've got a story about someone you're nemesis getting
something that you deserved. Good one, very good one. Okay,
what Chuck just said? Wrap it up, spanking on the bottom.

(24:14):
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