Special Briefing: Stagflation Ahead? Inflation and Recession

Inflation Brings Fiscal Challenges, Recession Risk

(This event, and all Special Briefings, are now available as a podcast. Be sure to subscribe either on Apple Podcasts or wherever you listen to your favorite podcasts.)

By Stephen Kleege, Volcker Alliance Special Project Consultant

• “We’re at the precipice of a wage-price spiral” economist warns
• Rising costs for labor and materials constrain infrastructure projects
• California sees flat revenue growth ahead
• Competition for staff heats up in tight labor market

The fiscal outlook grew cloudier for state and local governments as the latest report on consumer prices showed persistent inflation, signaling a greater likelihood of recession as the Federal Reserve responds by raising interest rates, panelists said at a September 15 Special Briefing by the Volcker Alliance and Penn Institute for Urban Research.

“We’re at the precipice of a wage-price spiral,” though a repeat of 1970s-style stagflation remains unlikely, said Beth Ann Bovino, US chief economist and managing director, S&P Global Ratings. She noted the Fed’s more aggressive response to the current surge in prices and greater flexibility in labor markets than in the 1970s, when unions wielded more power and more wage contracts were indexed to inflation.

Moderated by William Glasgall, Volcker Alliance senior director, public finance, and Penn IUR Fellow, and Susan Wachter, co-director of Penn IUR, the briefing was the thirty-fourth in a series of sixty-minute online conversations featuring experts from the Volcker Alliance's national research network and Penn IUR, along with other leading academics, economists, and federal, state, and local leaders.

In addition to Bovino, panelists included, Mark Zandi, chief economist, Moody’s Analytics; Alison Premo Black, senior vice president and chief economist, American Road & Transportation Builders Association; Gabriel Petek, legislative analyst, State of California; and Hughey Newsome, chief financial officer, Wayne County, Michigan.

The webinar came two days after the US Consumer Price Index excluding food and energy unexpectedly rose by 6.3 percent in August over the level of a year ago. Wachter said the worse-than-expected report raised the possibility that the Fed would increase its benchmark rate by a full percentage point at its September 21-22 meeting, rather than the 0.75-point move that was anticipated in financial markets.

“I was disappointed and disconcerted by the CPI number. It shows that inflation is broad-based and feels more entrenched than I would have thought,” Zandi said. “Continued acceleration in rent growth … may be more of an issue for longer than I expected.” He also noted rapidly rising wages in the health care sector due to the Covid-19 pandemic and said he sees fifty-fifty chance of a recession by the latter part of 2023 or early 2024.

Illustrating the pressure this is putting on budgets, Glasgall said New Jersey plans to cover much of a 21 percent increase in medical insurance premiums for state workers.

Inflation also is taking a toll on transportation spending as governments start to implement Covid relief and infrastructure programs. Higher costs and the lack of availability of materials “is having an impact on bid prices and how far some of these dollars are going to stretch,” Black said. “We’re facing issues of labor. We’re adding a number of jobs in heavy construction in the industry but wages are up, those employees are working more hours, and we also have low unemployment and a lot of job openings. So there is pressure there.”

California in May began to incorporate the increased risk of recession into its budget forecasts based on inflation and low unemployment, a slowing housing market, falling consumer confidence, and an inversion of the bond yield curve. “Our judgment is it’s been difficult for the Fed to navigate a soft landing” in the economy when those conditions exist, Petek said. After two years of strong growth in state tax revenues, he said, “we’re calling for pretty flat revenue growth over the next several years.” His office also sees a 70 percent likelihood that tax revenue will be below budget assumptions in the current fiscal year.

Wayne County, where Detroit is situated, is reliant on property taxes for revenue, but limited in how much money it can collect in an inflationary environment, Newsome said. “Costs continue to go up for the county, however we can’t necessarily capture the entire growth or appreciation in taxable values,” he said. Newsome said the county faces an increased challenge in providing services as it tries to compete with the private sector for workers in the tight labor market. Inflation is “starting to really hit us now,” he said.