Leland Spelman’s Post

Most former central bankers I’ve talked to over the years say there’s one economic scenario that keeps them up at night. Contrary to what you might think, it’s not a recession nor inflation. It’s the thought of both happening at once: “stagflation.” As the Fed gears up for its second rate-setting meeting of the year, officials are likely going to be debating whether that nightmare could seep into their reality — and what they might even be able to do about it. Stagflation is the worst of both economic worlds. Usually, it signals that prices are rising (bad) while the economy is slowing (also bad). They’re two economic ingredients that typically don’t go together. When prices rise, it typically signals that the U.S. economy is running red-hot — not losing steam. It’s happened once before: in the 1970s. Economic historians suggest that a "perfect storm" of policy missteps is necessary to create stagflation, but supply shocks that disrupt production and increase costs are usually always the common denominator. Stagflation has been the elephant in the room during a volatile few weeks in the stock market. The S&P 500 has dropped almost 9% from its record high on Feb. 19, even briefly sinking into correction territory. Investors began betting that the Fed could cut three times this year, while consumers’ inflation expectations rose the most since 1993. For Fed policymakers, though, those dueling economic scenarios are troubling. Usually, the Fed raises interest rates when inflation is hot and cuts borrowing costs when recession risks are rising. But when both sides of their dual mandate could be in jeopardy, they essentially have to make a tough choice. Which should they prioritize: maintaining a strong job market or ensuring price stability? Which could have the biggest consequences if left unchecked? “I suspect they will say it will be very costly to bring inflation down if we let it get very high. Therefore, in order to prevent us from having to do more damage in the future, we'll lean toward making sure that inflation doesn't get out of hand,” Erica Groshen tells me. Officials are heading into their March meeting with at least some good news. Prices rose less than expected in February, with the year-over-year inflation rate falling to 2.8% from 3%. Still, that doesn’t reflect the recent batch of tariffs that the Trump administration implemented — and another slate that's been delayed until early April. We'll all be watching what Fed officials signal in their new economic projections, set to be updated on Wednesday. Could the U.S. economy be at risk of stagflation — or at the very least, stagnation? Which side of its dual mandate is the Fed likely to focus on? Let me know your thoughts, and read our preview of the Fed meeting below. https://lnkd.in/eJQ7hM9