If you have never heard of Stagflation before I have included some relevant information from Wikipedia below.
Basically Stagflation is a period where the economy is slowing down (we just had the highest unemployment number in ages last week), and where prices are going up (inflation).
Why is Stagflation a problem? The Federal Reserve is basically powerless to do anything about it. Right now if they lower interest rates then the value of the Dollar falls leading to more inflation. More inflation means prices of everything go up including oil which is the biggest problem right now. When oil goes up it causes nearly all prices to go up because everything has to be transported somewhere... mostly using oil.
If the Fed increases interest rates it reduces the growth of the economy by making it more expensive to borrow for businesses. This slows the economy down even more leading to more unemployment.
So in this case... and everything seems to be pointing to Stagflation - the Federal Reserve is powerless to help the economy. If they keep interest rates low then prices of everything go up leading to runaway inflation. If they raise interest rates then they risk harming an economy which is already weak because it will costs more to borrow money.
Many expect the Federal Reserve to start raising interest rates in very small increments - perhaps 1/4 at a time. Clearly they know the risks.
How do we get out of it? If I knew that I would not be writing a blog about Denise Richards posing nude for Playboy. But I thought considering what is going on right now I should at least make an attempt to bring it to your attention.
Back to stupid stuff...
From Wikipedia :
Stagflation is a period of inflation combined with stagnation (that is, slow economic growth and rising unemployment), generally including recession.
Economists have identified two principal contributing causes of stagflation. First, stagflation can result when an economy is slowed by an unfavorable supply shock, such as an increase in the price of oil in an oil importing country, which tends to raise prices at the same time that it slows the economy by making production less profitable. Second, both stagnation and inflation can result from inappropriate macroeconomic policies. For example, central banks can cause inflation by permitting excessive growth of the money supply, and the government can cause stagnation by excessive regulation of goods markets and labor markets. When combined, the presence of both these factors is more than sufficient to launch an era of stagflation. For example, policies which promote growth in the money supply to allow consumers to afford higher priced oil contribute as a cause for runaway inflation, even if implemented to fight stagnation or recessions.
Stagflation becomes a dilemma for monetary policy when policies usually used to
increase economic growth will further increase runaway inflation while policies
used to fight inflation will further the decline of an already-declining
economy. Stagflation only becomes a problem when the marginal impact of the
further use of the tools available to assist central bank direction of the
domestic economy do more marginal harm than marginal good, if used. Generally
the central bank can either stimulate the economy or attempt to rein it in
through the mechanism of adjusting the domestic interest rate, its primary tool.
Adjusting the rate down tends to improve growth but it may ignite systemic
inflation. Adjusting the rate up tends to fight inflation but it may impinge
upon growth. During periods properly described as stagflation both problems
co-exist. Major economic conditions of unusual proportions will have already
created crises on both fronts before stagflation can set in again. Stagflation
is the name of the dilemma which exists wherein the central bank has rendered
itself powerless to combat either inflation or stagnation, having brought into
action every tool of measurement and intervention within its power or
Part of the difficulty the national central bank faces with stagflation is that inflation may occur selectively among asset classes. For example, by the end of 2007, U.S. home values were falling (deflation) while consumer prices began to rise (inflation). Efforts of the Federal Reserve to aid falling home prices by lowering interest rates to make mortgages more affordable may increase inflation, since consumer purchasing power increases as loan interest rates drop. The central bank, in this case the Federal Reserve has a difficult, some say impossible task, at finding the “perfect interest rate” in a stagflation scenario