Here comes stagflation—again

An entire generation has grown up without any need to learn the meaning of the word “stagflation,” but sadly, that is about to change. News reports indicate that the word might be making a painful comeback.

The term was coined in the 1970s to describe an economic environment that the ruling class thought was impossible: the simultaneous presence of high inflation and low growth. The dominant Keynesian models saw inflation as the remedy for low growth, therefore inflation and stagnation should not be able to occur at the same time. In more ways than one, Keynes and his disciples sought to overturn the moral universe of the Victorian world.

The specific application of that revolution in economics was the rejection of the virtue of savings in favor of the theory that spending is the driver of growth. Keynes called this “the paradox of thrift.” But he misunderstood thrift and openly embraced erroneous thinking. Nevertheless, Keynesian economics gained dominance in the academy and later in the policy-making apparatus. Nation after nation embraced the fiction that massive government spending (and borrowing) would save their economies.

The embrace of this fiction left the nation’s governing elite perplexed in the 1970s when inflation soared and growth dropped. As the nation stumbled from recession to recession, the central banks kept applying more and more of the “medicine” of easy money. Like a medieval doctor calling for more and more bloodletting as the patient fades, government policy drained the value of the dollar and was surprised by the deepening malaise.

The term “stagflation” was coined to describe this strange new, allegedly impossible reality. Providentially, Robert Mundell and Arthur Laffer had been quietly rebuilding the classical view of how an economy actually works in a form that Wall Street Journal editorialist Jude Wanniski dubbed “supply-side economics.” The supply-side approach revived lost truths. Money should be held stable in value and not debased in a fruitless attempt to stimulate growth. Growth comes from proper incentives for wealth creation such as low taxes rather than from money creation. Supply-side thinking had been relegated to the utter fringes of the field, that is, until stagflation stymied “the best and brightest.”

Rep. Jack Kemp quarterbacked the political offense, promoting Laffer’s ideas in Congress and then persuading President Ronald Reagan to take up the playbook. Reagan supported Federal Reserve Chairman Paul Volcker’s painful contraction of the money supply to wring inflation from the system and pushed a series of tax cuts through Congress to get growth back on track. Stagflation was utterly demolished: Tax cuts ended the “stag” and monetary discipline ended the “flation.” The rest is history.

But like so much history, it’s now tragically forgotten. First, the monetary discipline that mostly held during the long reign of Reagan’s Fed appointee, Alan Greenspan, began to falter. Then the Great Recession caused the central bank to break numerous restraints on its power with unprecedented “temporary” emergency powers that have yet to be withdrawn. The COVID crisis took things to a new level: Lockdowns brought the economy to a screeching halt and the old Keynesian playbook (both Republican and Democratic editions) said the solution was to print, borrow, spend, repeat. That’s why a new generation needs to learn the word “stagflation.”

But we don’t just need to relearn the painful lessons of what stagflation is and why it happens, we must also relearn how to beat it. The last time we were here, we got out of it. Yes, it was painful, and it will be painful again.

It starts with a recovery of Christian anthropology, the Biblical conception of human nature. Humans were created in the image of a Creator, which means we are also makers. We take God’s good creation and work to bring it to fruition.

Supply-side economics has that at its core: Economic policy should focus on the creation, not the consumption, of wealth. That’s why it’s called “supply-side.” It recognizes that, though economies involve both supply and demand of goods and services, the main challenge is supply, not demand. Human nature is good at demand; demand is always infinite. The trick is getting people to supply the needs and desires of other people. That means removing disincentives to wealth creation such as high taxes and subsidies for idleness. It means encouraging savings, which is just another word for capital, upon which all economic progress is based. It does not mean using inflationary policy to punish savers so that they turn themselves into spenders.

The stagflation of the 1970s made way for the supply-side revolution of the 1980s, which lifted billions of God’s children out of poverty. It was done before, so it can be done again.