An explanation of stagflation


Stagflation, or recession-inflation, is an economic phenomenon marked by persistent high inflation, high unemployment, and stagnant demand in a country’s economy. During a particularly severe period of economic conditions in the 1970s, rising inflation and falling employment held back economic growth in the UK and seven other major market economies, and investors in equity markets suffered greatly. as a result.

Key takeaways

  • Stagflation is an economic phenomenon marked by persistent high inflation, high unemployment, and stagnant demand in a country’s economy.
  • If your portfolio has more aggressive investments or is not diversified, and the economy seems to be approaching a period of stagflation, it may be time to reduce your risk.
  • Stagflation can be a reason to delay making large purchases, such as buying a home, especially if the area where you live is experiencing a housing bubble.
  • A solid long-term financial plan is the best way to protect your finances from stagflation; If you’ve been living within your means, stagflation shouldn’t have a major impact on the way you live your life.

After Iain Macleod, a politician from the British Conservative Party, used the term stagflation during a speech before Parliament in 1965, it was adopted by the media that began to use it when referring to the economic conditions that impacted the country from 1973 to 1982 . The term stagflation is an acronym for the words stagnant and inflation. Since then, economists have studied what factors lead to stagflation and developed methods to measure it. Their findings also include practical suggestions on how investors can protect their finances during periods of stagflation.

How is stagflation measured?

Stagflation is not measured by a single data point, but by examining the direction of a variety of indicators over an extended period of time. Rising prices and rising unemployment are two of these data points. The direction of just one of these indicators does not necessarily indicate the potential or presence of stagflation. Rather, the phenomena are considered together.

Increased cost of goods and services

An increase in the cost of food, energy, or other individual items is generally not perceived as a sign of stagflation. However, a general increase in the cost of goods and services can be an indicator. Investors who want to anticipate these increases can monitor trends in the Producer Price Index (PPI) and the Consumer Price Index (CPI).

The PPI measures the average change in sales prices received by domestic producers of goods and services over time. From an investment analysis perspective, it is very useful for analyzing potential sales and earnings trends in a variety of industries. From the point of view of economic analysis, movements in the PPI show whether the cost of production of goods is increasing or decreasing.

The CPI measures the weighted average of prices of a basket of consumer goods and services. When tracked over time, the CPI provides information on the direction in which consumer prices are headed. The CPI is often called “headline inflation.” A normal increase in the CPI is less than 2% per year. When that number exceeds that, investors start to fear inflation.

Price increases are not the only rising indicator suggesting the possibility of stagflation. A rising unemployment rate is another indicator.

Decreased productivity

The decline in gross domestic product (GDP) and productivity are indicators of an economy in crisis. GDP tracks the monetary value of all finished goods and services produced within a country’s borders in a specified period of time. In a healthy economy, this number is generally increasing. Productivity is an economic measure of output per unit of input. Inputs include labor and capital, while output is generally measured in income and other components of GDP, including commercial inventories.

Productivity measures can be examined collectively across the economy, or industry can examine them individually to examine trends in labor growth, wage levels, and technological improvement. Declining productivity is generally a sign of an economy in crisis.

Why does stagflation occur?

There are multiple theories about why stagflation occurs put forward by Keynesian, monetarist, and supply-side economists.

Keynesian economists blame supply shocks for causing stagflation. For example, they cite rising energy or food costs as the root cause of the economic problems of stagflation. Monetarist economists cite too rapid growth in the money supply to create a situation where there are too many dollars chasing too few goods. Supply-side economists blame high taxes, over-regulation of businesses, and a persistent welfare state that allows people to survive without working. There are additional theories that stagflation is simply a natural part of the business cycle in modern economies or that politics or social structures are to blame for stagflation.

Failure to forecast, avoid and contain stagflation once it occurs suggests that the exact forces that create stagflation are not yet known. An effective method to address stagflation once it occurs is also unknown. During the 1970s, stagflation persisted in the US despite the best efforts of the government to quell it. The trend finally came to a halt when the Federal Reserve raised interest rates to the point where borrowing was impossible for many segments of the economy, and the country fell into a deep recession.

How to protect your finances from stagflation

A solid long-term financial plan is the best way to protect your finances from stagflation. If you’ve been living within your means, stagflation shouldn’t have a major impact on the way you live your life.

When stagflation occurs, don’t panic and sell your stocks and bonds and invest in rare artwork, gold, or other unusual commodities. Stagflation is not a good reason to abandon a sound investment strategy entirely. However, if your portfolio has more aggressive investments or is not well diversified, it may be time to reduce your risk.

Stagflation can also be a reason to delay making large purchases, such as buying a home, especially if the area where you live is experiencing a housing bubble. However, if you are employed and have money to spend, you should continue to make regular purchases. You should also continue your saving and investing habits.

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Mark Holland

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