What is Stagflation?
Stagflation, also known as the economic recession, is characterized by slow economic growth and relatively high unemployment—or economic stagnation—which is at the same time accompanied by rising prices (i.e., inflation). Generally, stagflation occurs when the money supply is expanding while supply is being restricted.
Stagflation can be alternatively defined as a period of inflation combined with a decline in the gross domestic product (GDP). Such an unfavorable combination is feared and can be a dilemma for governments since most actions designed to lower inflation may raise unemployment levels. Policies designed to decrease unemployment may worsen inflation. While debating among economists, Elliot Eisenberg, chief economist at GraphsandLaughs, an economic consulting firm, mentioned the short conclusion sentence, which was, “The general notion of stagflation is high inflation and high unemployment.”
The Causes of Stagflation
Stagflation is costly and challenging to eliminate, both in social and fiscal terms. There is no consensus among economists on the causes of stagflation. Each economics school offers different points of view on this economic situation. However, two major hypotheses can be advanced: supply shock and poor economic policies.
- The supply shock theory suggests that stagflation occurs when an economy faces a sudden increase or decrease in the supply of a commodity or service (a supply shock), such as a rapid increase in the price of oil. In such a situation, prices were increased, making production costlier, whereas it was less profitable, as shown by the decelerating economic growth. According to the oil price case study, one theory states that stagflation is caused when a without-noticed increase in the cost of oil reduces an economy’s productive capacity. In October 1973, the Organization of Petroleum Exporting Countries (OPEC) issued an embargo against Western countries. This caused the global price of oil to rise dramatically, thus increasing the cost of goods and contributing to a rise in unemployment.
- Poor economic policies: Stagflation and inflation are both the result of poorly thought out economic policies implemented by each government. Harsh regulation of markets, goods, and labor in an otherwise inflationary environment is cited as the possible cause of stagflation. For example, the government can create a policy that harms industries while simultaneously growing the money supply too rapidly. The simultaneous occurrence of these policies can lead to slower economic growth and higher inflation.
In the past, a case study of stagflation in the 1970s
By the late 1960s, the post-World War II economic boom began to fade. As the US faced greater international competition, a decline in manufacturing jobs, and a massively expensive war in Vietnam, unemployment rates and inflation arose. Then, in 1971, former president Richard Nixon undertook a series of measures intended to create better jobs, remedy inflation, and protect the US dollar; the measure was called “Nixon Shock.” It was declared a 90-day freeze on wages and prices, a 10% tariff on imports, and the removal of the US from the gold standard. Meanwhile, the Federal Reserve attempted to fight stagflation using monetary policy. Later, between 1971 and 1978, the Fed raised the federal funds rate to fight inflation, then lowered it to fight the recession. The discontinuous measures confused households and businesses and ultimately drove inflation higher. The price of oil per barrel initially doubled, then even tripled, pushing inflation higher and further straining an already struggling US economy. During that time, businesses passed those costs on to consumers, but they also cut back on production (increasing unemployment) as the supply shock made goods more scarce.
In the end, DeKaser said, “The worst part of the experience from the 1970s was the aftermath,” and he added, “To reverse the momentum of ever-higher inflation, a severe recession was required (1981–82), and it took over a decade to get over the fears of an inflation recovery, which it wasn’t until the 1990s that investors began to seriously pass over such a threat.”
In a present time
Although the prices of many goods and services have risen, we are not currently experiencing stagflation because the global economy is doing well and unemployment is low due to vaccinated people. In April, the unemployment rate was 3.6% in the US, almost exactly what it was before the COVID-19 pandemic. “This is certainly not yet stagflation,” said Eisenberg. However, given the potential supply shocks, we could experience from events around the world, there is a risk we could enter a time of stagflation in the future.
During times of stagflation, there is an increased financial risk. The possibility of a loss in income increases with rising unemployment. And for the households that manage to keep their jobs, their purchasing power is eroded by the sudden increase in prices for everyday necessities. “It’s a double whammy because you’re still paying higher prices for goods and services.” But now at the same time, you have to contend with the effects of slower domestic [economic] activity, “Piegza mentioned.
How to overcome it when stagflation comes
Even if we don’t enter a period of stagflation, slow growth in the economy isn’t out of the question. The Fed is raising interest rates to fight inflation and in the past, that has increased the chances of a recession, according to Eisenberg. It’s going to be a dicey situation and the chances of the Fed getting it wrong are high because they don’t know the future, he said. Although the future is uncertain, there are precautions you can take to prepare a long-term plan to cope with the unexpected situation.
- Keep an eye on your spending and saving: Take the time to establish a budget and prioritize your spending and saving to align with your most important financial goals. If you’re in a position to delay expensive purchases, you may want to consider it. “The market’s telling me don’t buy the car, don’t buy the camper, don’t buy that stereo system, or whatever it is, and ultimately it’ll get cheaper down the road,” Eisenberg says. Consider using the money you’re not spending to pay down debt or build up your emergency fund. Experts differ on how much savings you should have, but starting now will put you in a more secure position later.
- Look for Ways to Increase Your Income: As the cost of housing, gas, and food go up, even if your income stays the same, you’ll have less leftover at the end of the day. “Wages aren’t keeping up with inflation,” Eisenberg says. “Real incomes are declining.”With unemployment so low,” firms are desperate to hire, Eisenberg says. Look into finding a better-paying job or negotiating a higher salary with your current employer. If you’re not in a position to negotiate for higher pay or find a new job, you can diversify your income in other ways. There are all sorts of profitable side hustles you could dip your toes into this year.
By Ashley Jones