In the 1970s, economists were confronted with the unlikely combination of faster inflation and a weak economy marked by high unemployment. The phenomenon became known as “stagflation.” Former Federal Reserve Chairman Alan Greenspan brought renewed focus to the term when he recently said the economy is moving back into stagflation and that the bond market may be in a bubble about to burst.
Greenspan, however, may have gotten the diagnosis wrong because the opposite is occurring with a twist: Inflation is slowing, but in a sluggish economy with low unemployment. Economists could dub this “stallflation,” as inflation today is being driven by a secular decline in productivity and potential output.
An economy that grows barely above stall speed isn’t likely to experience inflation like in 1970s that would cause a more serious stagnation or recession. Even if a recession were to occur, it is more likely than not that interest rates may end up falling, refuting Greenspan’s expectation for a return of stagflation that could pop a presumptive bubble in bonds.
