Stag yes, flation no

Banking Crisis – Change in inflation over next two years
Wall Street Crash (1929) – Fell from -1% to -10%
Savings & Loans (early 1980s)- Fell from 15% to 3%
Japanese bubble bursting (end 1980s) – Fell from 3.5% to 1%
Swedish Banking Crisis (early 1990s)- Fell from 10% to 2.5%
Asian Financial Crisis (1997)- Fell from 4.5% to 1% (Thai data as proxy)
Global Credit Crunch (2007-?) – ?

Sure, food prices are rising (and will stay high), and oil is $100 a barrel – but the key driver of inflation is the difference between actual growth and the economy’s potential growth. As the output gap opens up as growth slows, disinflationary pressure builds – there is overcapacity, and no supply of credit. With a combined share of around 15% of the inflation basket, higher food and energy prices will hurt consumers – badly – but unless they can negotiate higher wages in response (unlikely) they’ll have to reduce spending elsewhere. Thanks to the credit crunch, borrowing to finance discretionary spending will be more expensive and harder to find. Central banks need not worry about inflation – but they must stop the banking crisis from accelerating. Ben Bernanke knows this, and that’s why we could see a 1% Fed Funds rate later this year.