Wednesday, October 24, 2012

Why This Time its Different (At least we don’t have stagflation)

At the end of the 80s we had a housing market crash [check], at the end of the 80s we had a stock market crash [check], during the 80s we had high unemployment [check], and during the 80s we had high inflation,… ‘well there’s the problem’.

Because of the inflation, things weren’t so good coming out of the 80s and going on into the early 90s, and it actually took a bout of relatively high interest rates to get things ultimately back on track.

The big difference, the only difference, which makes this time different, is that what initially caused the recession. In the 80s we had an oil shock which constrained a key input in just about everything that America does. OPEC cut oil supplies and prices shot up, the amount of stuff produced fell and prices went up, all that led to inflation.

At the same time, as the amount of stuff produced fell, the people that made the stuff lost their jobs and unemployment went up. That was the trifecta of economic woes that resulted in a period of Stagflation.

This time, there were no shocks that affected supply of production inputs. And production fell, this time around because demand from households for consumption fell. House values fell, borrowing against houses fell, and all the business that revolves around household spending falls with it. That gives us high unemployment and low production.

There really is no inflation to speak of, which leaves room for a relatively painless transition for our current economic malaise to some level of sustainable, albeit moderate growth.

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