Inflation the year's only certainty
By PAUL HEISE
Stagflation is the word that economists use to describe a combination of inflation and unemployment. This is what we saw in the 1970s. Stagflation was a direct result of what economists call the "Political Business Cycle."
That same political business cycle has now been called upon to try to elect President Bush in 2004. Is it going to work? At what cost?
It's not as complicated as you might think. Midway through a presidential four-year cycle, the administration discovers that it is facing a recession with unacceptably high unemployment. History says the economy determines the result of presidential elections, so a president has to do something.
The president, wisely, and political principle be damned, stimulates the economy with the biggest spending and tax-cutting package he can push through congress. Congress likes to be re-elected, too, and it goes along, adding local pork projects to the president's stimulus package.
This fiscal spending stimulus takes about two years to turn the economy around. The president arrives at election time with a booming economy and low inflation. The incumbent gets re-elected. The problem is that he cannot and did not "fine tune."
The economy starts overheating, with rising inflation as producers bid up the prices of scarce resources. The Federal Reserve raises interest rates to slow investment and spending. If things are bad enough, there might even be a tax increase.
All this takes 18 months to 2 years to work through the economy, cause a "mild" recession and get the economy "on track." We are into the cycle again with a recession that has to be cured by the next election.
Admittedly, history never repeats itself exactly, so we should look at how this process applies this time around when things are different.
First, President Bush got his recession a little early. However, he justified that first tax cut on the basis of a surplus that had to be given back to the taxpayers. It was, however, just the right medicine for the economy and the political business cycle.
The spending portion of the cycle kicked in with a vengeance. Federal spending increased by 13.2 percent in 2002, by 15.2 percent in 2003, and it will increase by at least 8.9 percent in 2004. The economy will be booming when the president comes to campaign time.
The problem is the stupidity or greed or whatever of those second and third tax cuts. Those cuts, in addition to the increased spending, will be stimulating an economy at capacity. The problem will be way too much stimulus.
At this point, late 2004, Fed Chairman Alan Greenspan and the Fed will have to intervene and raise interest rates to slow down the economy and fight inflation.
This is the same mess that Paul Volcker, then-chairman of Federal Reserve, faced with President Reagan in the early 1980s. That episode occasioned the worst post-World War II recession, deficits that tripled the national debt and a huge Social Security tax increase.
Strangely enough, that is how things are the same. Things are different in that we are now engaged in a great international war against terrorism, we already have deficits larger than the largest of the previous era, and the latest tax cuts are so loaded that their effect will be intensifying at exactly the wrong time. And we are in a far more globalized economy.
All of these extra points add to the expectation of runaway inflation that may very well start in earnest before the election. The standard cure requires a near-depression as in 1981-82. Inflation rates could reach 10 percent, and interest rates could go past 20 percent by mid 2005.
That would be a prediction except that the economy doesn't stand still while politicians and economists try to play with it.
The really bad news is that we do not know why there is a lack of job creation and the stubborn unemployment that should have ended months ago. We are having our first "jobless recovery."
Economists are now predicting the end of the serious job losses that we have seen in the past two years. They are now saying hopefully that 100,000 new jobs will be created per month through 2004. The bad news they do not tell you is that the economy needs more than that, 150,000 new jobs per month, just to keep up with the new entrants into the labor force.
This failure of a booming economy -- and 8-percent growth is certainly that -- to create enough jobs is the new fact that economists don't know how to deal with. They don't know what is causing it, and they can't put it into their equations and models.
It's the wild card that makes all predictions a wild gamble. Maybe all of the above has changed. We simply don't know.
The political season and the political business cycle are in full swing. But the only safe prediction for 2004 is inflation. The only question: Will it arrive right before or right after the election?
Happy New Year!
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A resident of Mt. Gretna, Heise holds a Ph.D. in economics and is professor of economics at Lebanon Valley College. His column appears every other Thursday. He can be reached at:
heise@lvc.edu
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