That '70s Look: Stagflation

Lately, many people are hearing an echo — faintly perhaps but distinctly audible — of the stagflation of the 1970s.

Even as economic growth sags, oil and gasoline prices are surging to new heights. Gold is on the rise, along with the prices of such basic commodities as wheat and steel. And on Wednesday, with the latest government report on consumer prices, there are signs that overall inflation, after years of only modest increases, may be breaking out of its box.

For the Federal Reserve and its chairman, Ben S. Bernanke, all this could not come at a worse time. With the credit markets in disarray from the collapse of the housing bubble, Mr. Bernanke is cutting rates in a headlong rush to blunt the risks of recession.

But in putting its emphasis above all on reviving growth, America’s central bank, according to some economists and even a few Fed officials, may face a bigger inflation problem down the road.

“They are cutting rates with a bill to be paid later," said John Ryding, chief United States economist at Bear Stearns. “The question is not, will we get inflation, but how much will it cost to stuff the genie back in the bottle. This has the feel of 1970s stagflation.”

Over the last 12 months, consumer prices are up 4.3 percent on average, according to the Labor Department. The core index of consumer price inflation, which excludes food and oil, was 2.5 percent higher in January than a year earlier, significantly above the Fed’s unofficial comfort zone of a 1 to 2 percent underlying inflation rate. That’s a far cry from the double-digit inflation rates that battered the economy at times in the 1970s, but still worrisome.

Analysts like Mr. Ryding say that by tolerating such price rises and maybe even allowing them to escalate, the Federal Reserve is risking its hard-won credibility as an inflation fighter, which will ultimately require it to push up interest rates higher than otherwise to contain the damage.

Most economists still expect the Fed’s policy-making committee to cut interest rates again when it meets on March 18, engineering its sixth reduction since September. But the fears of a revival of inflation underline the difficult decisions it now faces.

Like the Fed, economists generally remain more concerned about the immediate threat of recession than the more distant fear of higher inflation. Recent data suggests an economy that may be in a downturn or close to it. The consensus view is that the expected slowdown is likely to create enough spare capacity to suck inflationary pressures out of the economy.

Moreover, even if some additional inflation is a side effect of the Fed’s prescription, many economists say, it sure beats the alternative. Once the interest rate cuts have nursed the economy through the next few difficult quarters, they say, the Fed can easily raise rates again to respond to any pickup in inflation.

“They are going to fix the wound now,” said David Durst, chief investment strategist of the Global Wealth Management Group of Morgan Stanley. “They are going to take care of the growth situation and then fight inflation when the economy gets stronger.”

Reinforcing this view, there are few signs that inflation is seeping into the labor market and pushing up wages in anticipation of higher prices to come.

That may be comforting to the Fed, but keeping inflation contained still may not be easy. In recent days some officials at the central bank have gone out of their way to warn that they are not prepared to let down their guard — even if it means that the Fed has to be less aggressive about cutting interest rates.

In a speech this month, Richard W. Fisher, president of the Federal Reserve Bank of Dallas, said “the Fed has to be very careful now to add just the right amount of stimulus to the punch bowl without mixing in the potential to juice up inflation once the effect of the new punch kicks in.”

Charles I. Plosser, president of the Federal Reserve Bank of Philadelphia, echoed that view, saying in a speech that “we cannot be confident that a slow-growing economy in early 2008 will by itself reduce inflation.”

“As we learned from the experience of the 1970s,” Mr. Plosser added, “once the public loses confidence in the Fed’s commitment to price stability, it is very costly to the economy for the Fed to regain that confidence.”

In a telephone interview, Mr. Plosser explained that the Fed seemed to be making progress against inflation in the first half of 2007 but he started to become more worried during the second half.

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