A Whiff of Stagflation

Added: 2026-05-23

[00:00:00]Hi, Paul Krugman here. Different city, different country, still not home.

[00:00:06]Unfortunately, couldn't manage to do this one in a cafe, though we have been sitting in cafes a fair bit. Uh, just want to weigh in on a really kind of alarming report on consumer confidence that came out today. Uh, this is the longunning University of Michigan survey of consumer sentiment.

[00:00:27]uh it is kind of it's time hallowed. I don't know that it's necessarily uh the gold standard. There are other surveys, but this is the one that people really do focus on most. And okay, the numbers are terrible. People were we're hitting a record low on consumer sentiment, which fits in with the general picture.

[00:00:48]We know that people are very upset about prices. They're very upset about economic management. They just don't feel that there's anyone making any sense who's in charge of things, which is all true. I mean, we can argue that objectively things are not as bad as you. We have consumer sentiment that's worse than at the depths of the financial crisis. We have consumer sentiment that is worse than during the stagflation of the circa 1980. And it's hard to say that that's really justified. But okay, uh the customer is always right. If if people are feeling this down um then we need to take that seriously but that is actually not the big issue. Um the really big issue is inflation expectations.

[00:01:35]Um now why do we focus on that? Uh the inflation for a short period of time is you know it's not good but it's it's tolerable. If we have a a year of elevated inflation, if you do something, even if you do something stupid, if you impose tariffs um and raise consumer prices or you start a war uh and mishandle it and you drive up oil prices, that is not good. But it only turns into a really really serious problem if it gets entrenched in the economy. That is the usually the term that people at the Federal Reserve use.

[00:02:19]Um and what they mean is this. If you think about how wages and prices are set, think about the process of inflation. Not all prices are set at the same time. There's a kind of a leaprogging in which um each individual company, each individual employer is setting prices based both on inflation in the past and on inflation that they expect in the future. They're looking over their shoulders at what they think competitors are going to be charging.

[00:02:45]They're looking over their shoulders at what they think is going to happen to the to their costs and they need to do that because many prices it's impractical and costly and and disruptive to change them too frequently. So you set prices for a year in advance, something like that. You set prices for a while, which means that a lot of what's happening to prices now is determined by what people think is going to be happening to prices in the future.

[00:03:14]So, uh, now it's difficult. We don't have great measures of what's in the minds of people who are setting prices, but we have pretty good or at least consistent over time measures of what consumers expect. And those are, you know, we're all living in the same society. So, that's telling you something about where we are in terms of expected inflation. Um, if inflation, you have a spike in inflation. If inflation comes and goes, but it doesn't get built into expectations of higher inflation for a long time, then okay, you ride through it. Maybe people vote the bums out, but you you ride through it. If it gets built into expectations, then it's a much a much more difficult situation. then you have to somehow ring those expectations of high inflation out of the economy because if you don't inflation will just feed on itself.

[00:04:07]Prices will rise because everybody expects prices to rise and those expectations will be confirmed and it just goes on. So you if you want to return to an acceptably low rate of inflation and if people are expecting a high rate of inflation then you kind of you know there may be other ways but normally what we do is we put the economy through a ringer which is what happened at the beginning of the 1980s after the inflation of the 1970s. Um inflation was eventually brought under control but it was that would happen through years of extremely high punishing unemployment. Um some people looking at inflation uh four years ago looking at the inflation of 2021 2022 predicted that we'd have to do the same thing that having seen a a burst of inflation after decades of low inflation that we were going to have to go through something like the the end of the 70s stagflation that we'd have to go through a severe recession with high unemployment for years to get inflation back down. Um something I called right. we all get things wrong with something I called right was I said no that that's not going to happen um that this is you're it's a false analogy and the reason I said it was a false analogy was because medium-term inspected inflation had not gone up very much now we go for medium-term because we know that short-term inflation people's expectations about that bounce around a lot often driven by fluctuations in gasoline prices but medium-term expectations are normally more stable so If they rise, that's an indicator that you are starting to get entrenched inflation and things will be really bad.

[00:05:44]Um, in 2022, well, it it sorry, go back to go back to 1980 and medium-term inflation expectations as measured by the Michigan survey uh were about 9%.

[00:05:59]Expect expected inflation over the next 5 to 10 years was 9%. That was really bad. That was why people had basically internalized the inflation of the 70s and expected it to continue indefinitely which meant that actually getting inflation back down to tolerable levels was very costly and very painful. Um in 2022 um well infla expected inflation over the next five years had crept up by a fraction of percentage point but it was still quite low. people were not at all building in anything like the um the expected inflation that prevailed before the the great painful disinflation of the 1980s. And so I I was quite confident that the dire predictions about what it would take to bring that inflation back down were were wrong.

[00:06:51]Well, guess what? uh in the especially in the last two months uh expected inflation over the next 5 years has gone up a lot. It's gone up to now it's 3.9% in the latest Michigan release. That is it's not 1980 but it's really bad. It's the worst we've seen on that number since the uh the early 1980s. It is saying that certainly ordinary the person on the street is starting to believe after the tariff shock and now the Iran shock that actually we're in a higher inflation environment and they're going to assuming that that people are making decisions about prices are thinking the same way they're going to start building that into pricing. So, we're starting to get the thing that everyone in the economics biz fears, which is entrenched inflation. And if that's happening, then the costs uh the policy failures, the policy foolishness uh of the of the past uh year and a half are going to be a lot bigger than anyone is now reckoning. on that this is going to be an extremely painful uh situation that we have. It looks at least according to these preliminary indications it looks as if Donald Trump has managed to create the kind of environment that we had at the end of the 1970s stagflation which means that this is going to be really really ugly and that we are going to be paying the price for these misadventures for years to come. Happy thought. Have a nice day.