The reemergence of inflation may be the economic story of the last year, but stagflation may well take over its relative’s starring role before long. Last week, the latest poor inflation numbers came just three days after a new World Bank report warning of a potential return to 1970s-style stagflation.

Recession fears have been increasing along with prices for a while now, and policy-makers may soon have to contend with the dual threat of low growth and high inflation. The Federal Reserve may have discovered a newfound commitment to raising interest rates, but it is less clear how it will respond if the economy contracts by more than is expected.

During the pandemic, the Fed focused on stimulating the economy and supporting lagging demand. Eventually, however, COVID-19 cases receded and consumer spending rebounded fast. The Fed was caught flat-footed, convinced that emerging inflation was merely transitory.

The central bank eventually responded by shifting toward tighter monetary policy with the aim of reining inflation in. The problem, however, is that higher interest rates (and the impact of quantitative tightening) slow economic growth (as, indeed they are meant to do) and make an economic downturn more likely. A truly soft landing is hard to pull off. In March, the yield curve inverted, historically a signal of impending recession, a further sign that the Fed may have to contend with slow growth and inflation simultaneously.

Sorting this out will not be easy, but there will be no chance of success without a credible commitment to reasonable price stability, carefully managed consumer expectations, and — this is something that is down to Congress and the administration — the restoration of fiscal discipline in Washington.

In Changing Fortunes, a seminal work that covers our last bout with stagflation, former Federal Reserve chairman Paul Volcker and Japanese economic official Toyoo Gyohten emphasize that the key is to get inflation under control first and achieve “reasonable price stability.” This term refers to “a situation in which ordinary people do not feel they have to take expectations of price increases into account in making their investment plans or running their lives.” The contention is that “over time the economy will work better, more efficiently, and more fairly . . . in an environment of reasonable price stability.”

That’s easier said than done. Breaking the back of inflation in the early 1980s required double-digit interest rates and caused a deep recession of a severity not seen again until 2008. Although most Americans currently cite inflation as their biggest economic concern, it is less clear to what extent they are willing to put up with higher interest rates and an economic slowdown in order to get it under control.

Inflation is an unusual economic problem because public expectations matter just as much as the underlying reality. If Americans believe that more inflation is on the way, they will change their behavior accordingly, regardless of what the numbers say. That may mean buying goods now despite strained supply lines, or pushing for higher wages to better afford the rising cost of services.

These actions might alleviate pain in the short term, but they ultimately encourage more inflation, forming a vicious circle that policy-makers have to break. Americans must believe that President Joe Biden and Federal Reserve chairman Jerome Powell are serious about containing inflation, but doing so requires fiscal and monetary policy working in tandem.

This prospect seems unlikely. President Biden was elected as a moderate, but since taking office, he has supported historically large spending packages and proposed even larger ones. Instead of following the lead of progressive senators Bernie Sanders (D., Vt.) and Elizabeth Warren (D., Mass.) — both of whom he defeated in the Democratic primary — Biden would be better served working more actively with more moderate members of his party, including those who publicly have expressed concern about inflation.

Instead, proposals such as student-loan forgiveness would only add to the inflationary pressure, and even if they don’t come to fruition, they undermine Americans’ belief that Biden is taking rising prices seriously.

Powell has committed to raising interest rates seven times in the next year, two of which have come already. But those increases would only amount to less than 200 basis points at a time when inflation likely still would exceed nominal rates. He also will have to rally support abroad. Inflation does not occur in a vacuum but rather is a global phenomenon that is affected by world events (which the Fed cannot control but may need to react to) and the actions of other central banks. No one country or president can simply pull the levers at their disposal to control prices.

There are those economists, many of whom didn’t see inflation coming, who now argue that we don’t need to worry about it because it will decline soon. That could be true, but the complicating factor of consumer expectations (particularly considering disruptions flowing from the Russian invasion of Ukraine) also means that price increases can come roaring back if adequate measures aren’t taken. Instead, committing to reasonable price stability and reducing federal spending would be steps in the right direction. Ignoring the danger that stagflation might return for the first time in over 40 years would be a risky gamble for most Americans — including the president.

Image: andrey popov