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Wall Street weighs threat of stagflation

Rachel Beck Associated Press

NEW YORK — A trend from the 1970s may be making an unwelcome return, and it has nothing to do with disco music, bad hair styles or bell-bottom pants.

Fears are growing on Wall Street about the possible return of stagflation, which often arises when tepid economic growth mixes with rising inflation. That toxic combination can cripple the economy, and while such a grim predicament has yet to emerge, there certainly are hints that stagflation could be brewing.

At the start of the year, the economy seemed to be in a good spot. The Federal Reserve, by raising interest rates multiple times, had managed to slow economic growth just enough to keep inflation in check. Some economists were even touting the rebirth of what is known as the “Goldilocks” economy – not too hot, not too cold, just right.

Those days now seem long ago. Worries over inflation and slow growth have become the buzz of economic circles and have rattled the stock market in recent weeks.

Stagflation in the 1970s grew out of the OPEC oil embargo that caused oil prices to quadruple. Inflation surged and economic growth was stunted.

This time around, a similar picture seems to be emerging. Oil prices soared above $58 a barrel in early April. And while prices have since retreated and now hover just above $50 a barrel, that is still well above the $40 a barrel hit a year ago.

Those price gains, coupled with a big upswing in other commodity costs and a steep decline in the dollar, have led to inflationary pressures appearing elsewhere in the economy. Core consumer prices, which exclude food and energy, rose at an annual rate of 3.3 percent in the first three months of this year, significantly higher than the 2.5 percent increase seen in 2004.

And that is affecting consumer and business spending, both of which retreated in the first quarter. Gross domestic product rose at a much lower-than-expected annual rate of 3.1 percent in the January-to-March period, its slowest growth in two years.

Given that scenario, economists are slashing their estimates for overall growth for the year to around 3.4 percent, down sharply from the 4.4 percent expansion for all of 2004.

Still, it isn’t clear if stagflation is really upon us. Though today’s situation in many ways appears to resemble the past, there are some clear differences between then and now.

“In the 1970s, economic growth was 2 percent and we had double-digit inflation. That certainly was a much bigger problem then we have today,” said David Wyss, chief economist at Standard & Poor’s.

Productivity also is much stronger now, meaning businesses can churn out much more while spending less, Wyss said.

Energy costs equal about 7 percent of GDP now, about half of what they were three decades ago. And while crude oil prices are rising, they still would need to surpass $90 a barrel to exceed the inflation-adjusted high set in 1980.

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