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Beware the Potential Stagflation

March 14, 2016

This month’s policy meeting will mean a difficult decision for the Fed – does it raise the federal funds rate or leave it unchanged?

The Fed’s Board of Governors wants to raise rates, and has wanted to for some time. The Governors finally did it last December and said they’ll do it four times in 2016 – a quarter point raise each in March, June, September and December.

But things aren’t going as expected. After all, the market is down and there are fears of a recession. Additionally, the inflation target is 2 percent, but it’s been close to zero since last month. However, core inflation, which measures inflation without highly volatile items like energy and food, rose 2.2 percent for the 12 months ending in January 2016, which was far higher than expected.

On top of all that, GDP growth has been meager (less than 1 percent since Q4 2015).

This confluence of forces puts pressure on the Fed to not raise rates. And it could all lead to a nightmare scenario – stagflation – which is when a stagnant economy meets high inflation. It’s happened before, like in the U.S. in the 1970s when oil prices rose dramatically.

Still, if inflation catches fire, the Fed won’t be able to control it because it’s nearly out of tools in the toolbox and a monetary shock of 1 or 2 percent interest rates could lead to recession.

Keep your eyes and ears peeled to the results of the March 15-16 Fed meetings. Our near-term economic future could hang in the balance.

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