This 1970s Monster Is Haunting the Economy Again

July 29, 2016, 2:50 PM UTC
Photo of Bee Gees
Photograph by Michael Ochs Archives

For the economy, it was truly a freaky Friday.

Economy watchers started their day with their worst surprise in months. The Commerce Department reported that GDP rose just 1.2% in the second quarter of 2016, well below economists expectations of 2.5%.

In fact, the report was so depressing that John Canally, Chief Economic Strategist for LPL Financial raised the dreaded “s” word, or stagflation, because the report showed accelerating wage growth even as economic growth was disappointing. Stagflation was a term used in the 1970s to describe the phenomenon of rising inflation during a period of weak real GDP growth, a combination that created much calamity, but that economists at the time thought would never occur together.

Think again, it seems.

So is a second act of stagflation a lot more likely than a disco do over? Not quite. Sure, wage growth is accelerating, but that growth remains modest. Overall, inflation is still well below the Fed’s 2% yearly target. That means that the central bank doesn’t have to face the rock-and-a-hard-place decision of raising rates during a weak economy in order to head off inflation. Janet Yellen is free to play the waiting game.

At the same time, there’s plenty in the GDP report to be concerned about. The biggest issue is a decline in business investment. This trend is something that Janet Yellen and the rest of the FOMC raised earlier this week when they announced their decision not to raise interest rates. A lack of corporate investment in the economy has been dragging us down for years now, and economists are not quite sure why.

Jason Furman, the Chairman of President Obama’s Council of Economic Advisors, has posited a few theories, namely that businesses see no reason to believe that economic growth will accelerate anytime soon due to a weak global economy and slow population growth. The sort of companies that are doing well in today’s economy, like Google and Facebook, don’t require all that much capital spending in expensive things like plants and equipment to growth their businesses.

But it is also important to remember this is the advanced estimate of GDP. There will be two further revisions of this number that could show that growth is actually stronger than this report suggests. The fact that job growth has remained relatively strong in 2016 suggests that this might be the case.

On top of that, the main driver of the fall in growth was businesses running down inventories. Inventory growth can be highly volatile, and when businesses run down their inventory, that usually means they will start building it back up shortly, and that’s bullish for future growth.

If that’s the case, the current economic expansion could be stayin’ alive for a lot longer.



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