Stagflation

Definition

Stagflation refers to an economic phenomenon where the timing of an increase in the inflation rate coincides with that of stagnant economic growth. The term stagflation is a combination of the words “inflation” and “stagnation.” The term was used by the 1970’s Chancellor of the Exchequer, Iain Macleod.

Key Highlights

• Stagflation occurs when an economy experiences slow growth, rising unemployment, and increasing costs all at once.
• It has been a common occurrence in the developed world since the 1970s.
• It also has some advantages because it has a profitable effect on some securities, asset prices, and stapled goods.
• The public, as well as the government, should research it in order to grasp how they can improve their chances for economic success.

Explanation

Stagflation was never seen as something that would occur in a real-world economy until it happened during the 1970s crisis in the West. Even the policymakers despise such a situation, and there are grave consequences if the State proves to be unable to handle the double-edged sword of the stagnant economy coupled with an abrupt increase in prices.

What causes such a unique phenomenon to occur are various reasons, out of which two that stand out the most are the supply shock and poor fiscal policies. With that said, it also has some positive connotations since it makes a profitable impact on certain bonds, commodity prices, and some stapled commodities.

While the State has its obligations to tackle the situation, stagflation should be studied by the citizens as well to understand where they can boost their opportunities for monetary success. A misery index was used to demonstrate it’s effects during the 1970s. This indicator, which was just the inflation rate plus the rate of unemployment added together, monitored how stagflation affected a country’s citizens.

Examples of Stagflation

The first ever example occurred in the United Kingdom in 1965 when Ian Macleod, a British Conservative Party member, used the term “stagflation” for the first time and warned the House Commons in the British Parliament about the gravity of the situation. This is what went in the U.K. in Macleod’s words: “We now have the worst of both worlds—not just inflation on the one side or stagnation on the other, but both of them together. We have a sort of ‘stagflation’ situation. And history, in modern terms, is indeed being made.”

A famous example is the first real-world premiere of the process, which caught the international eye. During the 1970s energy crisis, the Western world faced petroleum shortages, primarily the United States. It was around this time when the Middle East countries took a political decision to restrict trade-offs with the US, and the labor market conditions were flunking simultaneously despite an enormous amount of cash flow from the Federal Reserve.

 Causes of Stagflation

• According to one theory, stagflation happens once a country’s economic capability for production is decreased by a sharp spike in the price of oil.
• A classic example is the oil crisis of the 1970s, which led to a sharp increase in the price of oil on a worldwide scale, driving up the cost of commodities and fueling an increase in unemployment. Prices increased even as more people lost their jobs due to rising transportation expenses, which made it more costly to produce goods and deliver them to retail shelves.
• Poor monetary policies can also immediately play a role in economic downfall. For example, the government can create a policy that radically increases the minimum wage limit for industrial workers without foreseeing the impact it will have on the prices of a commodity that will lead to an immediate decrease in purchasing power for those not involved in the industrial sector. 
• Another constant theory is that of a supply shock. A supply shock is a sudden change in supply rate leading to a profound change in prices that are either causing an excessive supply or excessive demand. Excessive supply leads to losses for the producers because it exceeds way over the pace of demand, therefore threatening the employment rate in the future. Similarly, excess demand leads to scarcity due to the mediocre rate of supply, which also results in the sudden increase in prices of the aggrieved commodity, leading to a decrease in purchasing power.
• Another reason that is significant but not vastly popular is the end of the Bretton Woods System. The Bretton Woods system used a fixed amount of gold as a standard economic unit to establish financial and commercial relations between countries like the U.S., Canada, Japan, and more. When the dollar was accepted as the direct currency for trade and measure of a nation’s economy on the grounds of the international economy, the prices of gold and oil became volatile after many years of steadiness.

Stagflation vs. Inflation

1. Meaning:

• A prolonged rise in the overall cost of all products and services, not just a selective few, over time in an economy is referred to as inflation. Inflation results when the supply of money expands more quickly than the sector can create products and services.
• Stagflation occurs when there is significant unemployment, slow economic development, and inflation. These economic circumstances don’t typically coexist. 

2. Impact:

• The people most adversely affected by inflation include those who are retired and on a government pension, traders who own long-term bonds, and people with credit line debts.
• As a result of reduced salaries and a higher chance of job loss during stagflation, consumer confidence may be affected. Higher manufacturing costs and reduced sales might hurt small businesses, resulting in lower company profits and lower stock values, which would affect investors.

3. Causes:

• The primary cause of inflation is an imbalance between supply and demand for services and goods. Additionally, inflation will happen if the money supply expands more quickly than GDP.
• The economy tends to slow down or “stagnate” when growing inflation is frequently followed by the Federal Reserve’s adoption of a more aggressive monetary policy, which eventually results in stagflation.

4. Duration:

• In most of the world’s economies, inflation is, to some extent, a constant. The Great Inflation, which affected more severe settings in the US, lasted from 1965 until 1982.
• Instead of years, stagflation is typically assessed in terms of a few months or quarters. As an extreme scenario, stagflation persisted from 1973 to 1982 in several economies.

Advantages of Stagflation

Can a citizen foresee any advantages in such adversity? While many assets tend to perish in stagflation, there seem to be some resilient entities that work their way through the situation. The following are those:

• A bond is a loan in which the money lender- the bondholder- for the government or a company puts an interest rate that the borrower is obliged to pay frequently until the initial amount lent is returned. The amount returned, along with the interest rate, is known as the ‘principal.’ Bonds whose interest rates are adjusted with the inflation rate tend to benefit a lot to the bondholder.
• With producers always looking for increasing profits within the capacity of their production units, inflation offers a mandatory price rise to the commodities for a while until a balance between supply and demand is reached.
• During inflation, a consumer’s budget is refocused solely on stapled commodities provided by the cheapest producer available in the market despite the price rise. Companies providing such commodities come from the field of healthcare, energy, and food.

Disadvantages of Stagflation

• A country experiencing stagflation will see rising commodity prices, diminished spending power, low GDP, firm closures, a fall in consumer expenditure, and an increase in unemployment as a result of corporate layoffs.
• Dealing with stagflation is like only choosing between the blue pill and the red pill with their setbacks. Let’s say that the blue pill helps you solve inflation but then comes the economic recession. On the other hand, if you choose a red pill to solve the employment rate, which is a key symptom of recession, it leads us back to inflation. So it’s misery not for the nation but those running the State as well. The problem of stagnation is difficult to resolve once it starts, both in social terms and budget deficits.

Tips to consider when getting your company ready for stagflation

1. Increasing your business’ production is the best strategy for avoiding stagflation. Consider investing in equipment or software that can automate tasks to deliver the same quantity of goods or services.
2. Look for strategies to reduce spending to counteract rising costs for labor and commodities. Finding methods to reduce expenses and counteract inflationary pressures is crucial.
3. Ask your vendors for longer payment terms possible in an effort to increase cash flow by lowering past-due accounts receivables (AR).
4. Take into account minimizing your debt. A debt with floating interest rates should be replaced with debt with set interest charges if the interest rate increases.
5. A company may be positioned to withstand even the worst financial crisis if one shifts investments into relatively low but recession-proof sectors like health, basic goods, utility, and discounted retail or if one ensures personnel flexibility in the recruiting process.

FAQs

Q1. What triggers stagflation?

Answer: Stagflation is a state of affairs where there is a high level of unemployment, poor economic activity, and increasing costs. The 1970s had stagflation as a consequence of monetary, fiscal, and oil crisis policies.

Q2. Is stagflation more detrimental than recession?

Answer: Stagflation is more harmful than a recession since it indicates that both inflation and unemployment are at historically high levels.

Q3. How does stagflation differ from inflation?

Answer: Stagflation is a mix of high inflation and concurrently poor growth. Inflation is an overall upward trend in the prices of goods and services over time.

Q4. What is the Solution to Stagflation?

Answer: Stagflation cannot be cured completely. However, attempts can be made to increase productivity to a level where it will result in more growth without more inflation. As a result, it would be possible to strengthen monetary policy and control the inflationary element of stagflation.

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