The New Normal And Asset Class Cycles

November 20, 2009

Will the 'new normal' really be slow economic growth, high unemployment and low asset returns?


The word “stagflation” became popular in the 1970s when stagnation of the economy and extremely high inflation (greater than 6 percent) were both evident during times of high unemployment. The head of
England’s Treasury was Exchequer Iain Macleod, who in 1965, gave a speech to parliament that included the first utterance of the term “stagflation” to describe economic conditions then. His economy was weak, inflation was climbing and the jobless rate was rising. These conditions were so rare that Exchequer Macleod’s reference to these conditions needed a new word that combined “Stag” and “flation.” “Stag” was drawn from the first syllable of "stagnation," a reference to a sluggish economy, while “flation” was drawn from the second and third syllables of "inflation" - a reference to an upward spiral in consumer prices.

Mistakenly, most of us reserve stagflation to describe conditions seen during the late 1970s and early 1980s, which made conditions that the Exchequer described in 1965 seem benign. This error caused me to review conditions that existed in the mid- to late-1960s, when stagflation was first uttered, and to then employ them as a starting point for measuring factors that could quantitatively define stagflation.

The late 1960s were dire enough to cause England and the
U.S. to warn its citizens to expect “hard times.” In 1971, former President Richard Nixon imposed wage and consumption price controls on our nation when the consumer price index (CPI) was running at 3.3 percent, real gross domestic product (RGDP - economic growth) was at 4.1 percent and the unemployment rate was 6 percent.

In 2006, I thought it was wise to measure conditions when stagflation was first used to define it, which led to the following analysis (updated through October 2009). This analysis also clarifies what Dr. Mohamed El-Erian of Pimco anticipates as a new normal of slow economic growth, high unemployment and low asset returns. He expects these conditions in the five-plus years possibly needed to recover from financial crisis.

Stagflation: Defined & Revisited

Stagflation is used more appropriately when it describes times when the following annualized readings are evident: the civilian unemployment is higher than 5.5 percent, RGDP is less than 2.5 percent and the inflation rate (CPI) exceeds 3 percent. Figure 1 shows the 54, 23 and 49 calendar years when these thresholds have been breached since 1890.




Stagflation is gradual and insidious. All instances took root after inflation rose above 3 percent. A stagflation episode was identified (defined) when unemployment rose above 5.5 percent and RGDP fell below 2.5 percent within two years after inflation exceeded 3 percent. Below the column labeled Annual Frequency in Figure 1, you will find 1, within 2” to depict this confirmation sequence for quantitative thresholds. CPI rises above 3 percent first, (1) with the others following within two years (2). For example, our current crisis was precipitated by a stagflation episode when the 12-month change in the CPI hit 3.5 percent in November 2007. It steadily rose to 5.6 percent by July 2008 and remained above 3 percent until November 2008. It has remained negative since, and in September 2009, the 12-month CPI was -1.3 percent. Stagflation often precedes and follows consumer price deflations.


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