Jerome Powell's Warning

Preparing for Stagflation

The Warning Signs

Jerome Powell, the Federal Reserve Bank chair, recently reported that the U.S. economy is at risk of experiencing slowing growth coupled with persistent inflation. This economic predicament is what economists call stagflation—a stagnating economy that simultaneously faces rising prices.

Powell's candid assessment was met with sharp rebuke and even threats of termination from the administration. This political pressure comes at a critical moment when the Supreme Court is evaluating whether the president can fire chairs of independent agencies, including the Federal Reserve. The timing couldn't be more consequential for our economic stability.

Learning from the 1970s and 1980s

To understand what might lie ahead, we need to look back at the last major period of stagflation in American economic history: the 1970s and early 1980s.

What Caused Stagflation Then?

The stagflation of this period emerged primarily from two major oil price shocks:

1. The 1973-1974 OPEC oil embargo quadrupled prices

2. The 1979-1980 Iranian Revolution disrupted supplies and caused another price spike

Image Source: https://www.kpbs.org/news/2012/11/10/gas-lines-evoke-memories-oil-crises-in-the-1970s

These shocks reverberated throughout the economy because:

• Oil was fundamental to manufacturing, transportation, and energy production

• Sudden price increases raised production costs across all sectors

• Higher costs forced businesses to raise prices while cutting production

The Economic Pain

The resulting economic conditions were severe:

• Inflation exceeded 14% by 1980

• Unemployment rates climbed above 10% by 1982

• Economic growth stagnated or contracted for multiple quarters

• Productivity growth declined

• The stock market performed poorly in real terms

Image Source: https://www.federalreservehistory.org/essays/recession-of-1981-82

Today's Parallels and Differences

Today's potential stagflation has different origins but similar symptoms. Instead of oil shocks, we're seeing:

1. Supply Chain Disruptions: The lingering effects of pandemic-related disruptions continue to affect production and distribution.

2. Labor Market Shifts: Structural changes in the labor market have created mismatches between available workers and jobs.

3. Monetary Policy Challenges: After a period of extraordinary accommodation, the Fed must tame inflation without crushing growth.

4. Isolationist Trade Policies: The current administration's tariffs and trade restrictions echo some of the protectionist measures that exacerbated economic challenges in the 1970s.

The 2025 tariffs are our version of the 1970s oil shocks.

What Worked Last Time?

The stagflation of the 1970s wasn't easily resolved. Initial policy responses proved ineffective:

• Price and wage controls under President Nixon (1971-1974) failed

• Expansionary fiscal policies, hoping to stimulate growth only fueled inflation

• "Stop-go" monetary policy that alternated between fighting inflation and unemployment created uncertainty

The stagflation was finally defeated in the early 1980s when Federal Reserve Chairman Paul Volcker implemented extremely tight monetary policy, raising interest rates to nearly 20%. This caused a severe but necessary recession that broke the back of inflation.

Image Source: https://www.reddit.com/r/TheWayWeWere/comments/tt8hop/1980s_mortgage_rates/

The only difference between the 1980s and today is that the cause of stagflation in 1980 was due to external forces. Today, the pain we are experiencing is unnecessary and self-induced pain from the U.S’s tariff policy and isolationist rhetoric.

Preparing for What's Ahead

If stagflation takes hold, what can you do to prepare?

1. Understand Asset Performance in Stagflationary Environments

   • Traditional stock/bond portfolios tend to underperform

   • Cash becomes more valuable as interest rates rise to combat inflation

2. Develop Recession-Resistant Career Skills

   • Focus on sectors that remain essential even during economic downturns

   • Build versatile skills that transfer across industries

   • Consider how your expertise might be valuable in a changing economic landscape

3. Watch for Policy Responses

   • Monitor Fed communications for shifts in approach

   • Pay attention to fiscal policy changes that might address supply-side constraints

   • Understand how trade policy affects both inflation and growth

4. Historical Perspective is Key

   • The 1970s stagflation wasn't resolved quickly or painlessly

   • Policy solutions often require significant economic adjustment

   • Political pressure on central banks historically leads to worse outcomes

The Takeaway

The potential for stagflation represents one of the most challenging economic scenarios for policymakers. The historical record shows that addressing it requires tough choices and often short-term pain for long-term stability.

The political pressure currently being exerted on the Federal Reserve is particularly concerning. As the 1970s demonstrated, central bank independence is crucial for making the difficult decisions necessary to restore price stability. When political considerations override economic realities, the stagflation problem typically worsens.

For those of us studying and working in economics, this period offers a rare opportunity to witness economic principles in action. The lessons of the past suggest that clear-eyed analysis and a willingness to accept necessary but difficult policy measures will be essential.

Until next time,

Dr. A

Economics with Dr. A is a weekly newsletter that brings you economic insights to navigate the complexity of our markets. Subscribe to my mailing list for analysis, historical context, and practical guidance for navigating our economy.

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