Stagflation is quite a rare phenomenon because inflation shouldn’t occur in a weak economy. In normal economic conditions, slowing growth prevents inflation, which causes consumer demand to drop just enough to curtail rising prices. Stagflation challenges traditional economic models that rely on the Phillips curve, where inflation and unemployment are expected to have an inverse relationship. According to classic theory, high inflation should coincide with low unemployment and vice versa, simplifying control through interest rate adjustments.
- Stagflation also reduces growth in companies, which could affect stock prices.
- During this extreme inflation, both bonds and stocks incur losses as a result of subdued stock prices from the lack of growth and the negative impact of high inflation on bonds.
- It presents a dilemma for economic policy, since actions intended to lower inflation may exacerbate unemployment.
- The cost of gold can move due to several factors, like the ability of mining and refining companies to produce gold and demand for gold from central banks and investors.
Stagflation doesn’t respond to the conventional monetary tools based on the Phillips curve (see figure 1). According to the classic theory, when inflation is high, unemployment is supposed to be low, and vice versa. The crucial factor in averting stagflation lies in the proactive approach of economic policymakers. The word “stagflation” is formed by blending “stagnation” and “inflation.” It was initially employed during the early 1970s to depict the economic state prevailing in the United States and other advanced economies during that period. It’s a perplexing situation that defies conventional economic theories, yet it has been a harsh reality faced by some economies. In this blog, we delve into the heart of stagflation, aiming to unravel its complexities and shed light on its implications.
What Is Stagflation, What Causes It, and Why Is It Bad?
Recessions are considered a normal part of the economic cycle, happen quite often, and historically last just under a year. Stagflation, meanwhile, is uncommon and, when it does rear its ugly head, tends to stick around. These types of economic crises are difficult to defeat because the traditional play of lowering borrowing rates to stimulate growth is taken off the table.
Meanwhile, a contracting economy with lots of spare capacity restrains price hikes and wage increases as demand slows. Those supply shocks followed a period of accommodative monetary policy in which the Federal Reserve grew the money supply to encourage economic growth. Meanwhile, global economic growth slowed sharply in the 1970s—a decade marked by two different recessions in the U.S. and the lead-up to a third one that began in 1980.
McMillan says that paying attention to both the underlying data and the headlines is important. https://traderoom.info/ “If you’re an investor, you need to play off expectations as much as reality,” he says.
Supply & demand, a cornerstone of inflation
Since the Federal Reserve (Fed) controls interest rates, some people believe that poor monetary policies were the root cause of The Great Inflation. In an effort to combat rising prices – particularly from the oil and energy crises in the 1970s – the Federal Reserve expanded the money supply. Increasing the money supply pushed prices higher, but since the economy’s growth wasn’t fast enough to balance out the influx of dollars, the economy wasn’t primed to stay ahead of inflation. Ultimately, this just resulted in more inflation and unemployment continuing to rise. Based on the few examples we have witnessed so far, it’s generally agreed that the main cause of stagflation is a major supply shock.
The crisis occurred when the United Kingdom tried to redeem $3 billion for gold. The United States didn’t have that much gold in its reserves at Fort Knox. That sent the price of the precious metal skyrocketing and the value of the dollar plummeting which sent import prices up even more. Under Bretton Woods, most countries agreed to peg the value of their currencies to either the price of gold or the U.S. dollar.
Inflation increases with unemployment, while economic growth slows down. The United States experienced notable inflation in 2021, with prices surging during the second half of the year. These high inflation rates don’t appear to be transient, and interest rates remain historically low. Supply chain issues have left businesses struggling to meet demand, the national debt is at an all-time high, and market experts are expressing concerns that stagflation is in our near future. Energy prices have gone haywire as of late, and there’s a supply crunch that seems to have wreaked havoc on nearly every industry. When disease and natural disasters strike, economies – like people – are destined to suffer.
How to Handle Stagflation?
This in turn will lead companies to cut expenses — notably labor costs,” she wrote. Affordability takes a hit as consumers find it harder to meet their basic needs, especially if they’re unemployed. Those employed are not spared either because they are at risk of lower wages and job loss, which will reduce their purchasing power. To curb these economic challenges, President Richard Nixon enforced regulations to freeze prices and wages. He also made it easier for the Federal Reserve to control the value of the U.S. dollar. Unfortunately, the actions only provided short-term relief and didn’t get into the root cause of the problem.
“The danger of stagflation is considerable today,” the World Bank warned this week. “Several years of above-average inflation and below-average growth are now likely.” Lenin is said to have declared that the best way to destroy the Capitalist System was to debauch the currency. By xor neural network a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens. By this method they not only confiscate, but they confiscate arbitrarily; and, while the process impoverishes many, it actually enriches some.
Whether or not the U.S. will experience another bout of stagflation remains to be seen. Haworth says that investors have been battling two headwinds—high inflation and rising interest rates—that don’t necessarily create a clearcut path for investing. While appealing, this is an ad-hoc explanation of the stagflation of the 1970s which does not explain later periods that showed a simultaneous rise in prices and unemployment. One theory states that stagflation is caused when a sudden increase in the cost of oil reduces an economy’s productive capacity. The economic theories that dominated academic and policy circles for much of the 20th century ruled it out of their models. In particular, the economic theory of the Phillips Curve, which developed in the context of Keynesian economics, portrayed macroeconomic policy as a trade-off between unemployment and inflation.
In other words, Nixon’s three attempts to boost growth and control inflation had the opposite effect. Typically, inflation goes hand-in-hand with economic growth, and an overheated economy is one possible cause of higher inflation. In an economy running hot by operating above its long-term potential, price increases are necessary to ration labor and other scarce inputs and to offset those increased production costs.
Consequences of Stagflation
There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose. So stagflation will show early signs late in 2022 and get roaring in 2023. By the end of that year, the risk of recession will be much higher, even though inflation will just be starting to decline. Stagflation is that period of time when employment is weakening but inflation is still high. However, aside from a brief but severe recession due to the pandemic lockdowns in 2020, the economy muddled through, with gross domestic product (GDP) mostly positive and relatively steady.