What Is Stagflation? What Causes It & Actions To Take 2023

what is stagflation
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Stagflation is a term that combines the phrases stagnation and inflation to describe an economic period characterised by high inflation, weak economic growth, and relatively high unemployment. Stagflation, also known as recession-inflation, is frequently accompanied with consumer constriction as a result of concern about the long-term repercussions of economic uncertainty.

Continue reading to learn what stagflation is, what causes it, and what you can do to reduce its impact on your personal finances.

What Is Stagflation?

Stagflation, a term coined in the 1970s, refers to an economic event characterised by high unemployment, poor growth, and significantly rising consumer prices. Because stagflation occurs seldom, there is little agreement on what causes it.

Interest rates surged in the mid-1970s and early 1980s as the Federal Reserve worked to offset inflationary pressures caused by sharply rising prices, notably in the oil industry. With inflation reaching 14.6% in 1980, the Federal Reserve raised its target federal funds rate to a record high of 20%, precipitating a recession. Prices were high, interest rates were high, and unemployment was high. While inflationary pressures are typical during periods of economic expansion, stagflation, or price increases during economic downturns, is uncommon.

The Misery Index depicts the anguish that this confluence of circumstances causes customers. The Misery Index is calculated by adding the rate of inflation to the rate of unemployment. Economists can use the index to assess how much the average person is struggling by measuring drops in spending and household wealth along with an increase in mortgage rates.

Understanding Stagflation

Iain Macleod, a British politician, first introduced the phrase “stagflation” in a speech to the House of Commons in 1965, during a period of economic stress in the United Kingdom.He referred to the combination of inflation and stagnation as a “‘stagflation situation.”

During the 1970s oil crisis, which triggered a recession with five consecutive quarters of negative GDP growth, the phrase was reintroduced in the United States.3 In 1973, inflation doubled and reached double digits in 1974. By May 1975, the unemployment rate had risen to 9%.

A misery index was used to demonstrate the effects of stagflation. This index, which was just the sum of the inflation and unemployment rates, tracked the real-world consequences of stagflation on the citizens of a country.

What Causes Stagflation?

The origins of stagflation are not well understood by economists. They have advanced numerous theories to explain how it occurs, despite the fact that it was previously thought to be impossible.

#1. Oil price fluctuations are to blame.

According to one idea, stagflation occurs when a sudden increase in the cost of oil decreases an economy’s productive potential.

The 1970s oil crisis is a great example. The Organisation of Petroleum Exporting Countries (OPEC) imposed an embargo on Western countries in October 1973. This caused the global price of oil to skyrocket, raising the cost of commodities and contributing to an increase in unemployment.

Producing things and delivering them to shelves got more expensive as transportation costs grew, and prices rose even as employees were laid off.

Critics of this idea point out that neither of the simultaneous times of inflation and recession that have occurred since the embargo has coincided with dramatic oil price shocks like those of the 1970s.

#2. Blame Poor Economic Policies

Another view holds that the combination of stagnation and inflation is the outcome of bad economic policy. Harsh restrictions on markets, goods, and labour in an otherwise inflationary environment are blamed for stagflation.

Some blame former President Richard Nixon’s actions for the 1970 recession, which may have been a prelude to subsequent episodes of stagflation. In an attempt to keep costs from rising, Nixon imposed taxes on imports and froze wages and prices for 90 days. The quick escalation of prices after the limits were lifted caused an economic pandemic.

While attractive, this is an ad hoc explanation for the 1970s stagflation that does not explain succeeding periods of price and unemployment increases.

#3. Blame the Gold Standard’s Demise

Other hypotheses suggest that monetary variables may also contribute to stagflation.

Nixon abolished the final indirect remnants of the gold standard, bringing the Bretton Woods system, which had controlled currency exchange rates, to an end.

This decision removed the currency’s commodity backing and placed the US dollar and most other world currencies on a fiat foundation, removing most practical limitations on monetary expansion and currency devaluation.

Why is Stagflation Bad?

People are generally more financially secure when the economy is thriving and prices and unemployment are low. However, the global economy has recently witnessed inflation rates not seen in a long time, prompting some to warn of looming stagflation. However, as of publication, the unemployment rate remained at a low of 3.5%, alleviating some analysts’ concerns about stagflation.

Nonetheless, many experts predicted that 2022 would be a year of significant economic development when businesses reopened and people spent their amassed savings. However, reality has brought growing inflation rates that have exceeded all expectations, as well as poor economic development, which has increased economic suffering despite optimistic economic signals.

When high inflation and the threat of a recession coexist, the increasing cost of goods and the prospect of joblessness can put enormous strain on consumers. This may drive many people to postpone spending on particular things, increasing the danger of stagflation and potentially harming the overall health of the economy.

How to Prepare Your Finances for Stagflation

While it is difficult to foresee whether or not a recession or stagflation would affect you directly, it is never a bad idea to begin developing financial resilience today by following these measures.

#1. Improve Your Credit Score

Making on-time payments on all of your debts and avoiding carrying credit card amounts from month to month are just two methods to enhance your credit. If an emergency occurs and you do not have enough funds in your emergency or sinking fund, you are more likely to qualify for a loan, a home equity line of credit (HELOC), or another funding source if you have good credit.

#2. Cut back on spending

Consider what you need against what you want to help you save more money through difficult times. Plan ahead of time in case your car breaks down, your rent rises, or your job becomes insecure. Reduced monthly spending equals more money in the bank for essentials or emergencies.

#3. Pay Off Debts

Paying down or off debt might help to ensure a more stable financial future. If possible, strive to pay more than the minimum due on credit card or loan amounts each month, or consider consolidating high-interest debt into one manageable payment rather than several.

#4. Set aside Emergency Funds

A reasonable rule of thumb for saving is to have three to six months’ worth of living costs in your account. Consider creating a savings goal, automating the transfer of funds from one account to another, or utilising a savings-focused app like Qapital, which automatically rounds up your change to the nearest dollar and deposits it into your savings account.

#5. Find Additional Sources of Income

A little ingenuity can sometimes lead to other sources of income. Using a cash back credit card, which allows you to get cash back when you shop, finding a side gig, renting out your house as an Airbnb while you’re away, or driving for Uber for a few hours each week can help you prepare for stagnation if it occurs.

#6. Avoid attempting to time the market.

Timing the market is purchasing and selling stocks and assets in response to market moves in the hopes of minimising losses or enhancing gains. However, without a crystal ball, determining the optimal time to buy or sell is tough. Instead, if you invest equivalent amounts on a monthly basis in a 401(k), IRA, or other tax-advantaged investment vehicle, you’ll have a better chance of saving money for a rainy day.

Stagflation vs. Inflation

Whatever the cause, inflation has persisted despite periods of economic stagnation since the 1970s.

Some economists questioned the idea of a steady link between inflation and unemployment even before the 1970s. They contend that consumers and producers adapt their economic behaviour in response to or in anticipation of monetary policy changes.

As a result, prices rise in reaction to expansionary monetary policy without commensurate reductions in unemployment, whereas unemployment rates rise or fall in response to actual economic shocks to the economy.

This means that efforts to stimulate the economy during a recession may only inflate prices rather than promote actual economic growth.

Jane Jacobs, an urbanist and author, interpreted debates among economists about the reasons of the 1970s stagflation as a misplacement of scholarly concentration on the nation rather than the city as the fundamental economic engine. She felt that in order to avoid stagflation, a country should give an incentive for the development of “import-replacing cities”—that is, cities that balance imports and production. This theory, essentially the diversification of city economies, was criticised by some for its lack of research but carried weight with others.

Special Considerations

Most economists and policymakers have reached a de facto agreement on stagflation, basically redefining what they mean by the term inflation in the current era of currency and financial systems. Inflation is simply the result of persistently rising price levels and declining buying power, which are natural phenomena in both good and poor economic periods.

Economists and policymakers often expect prices to rise and are more concerned with accelerating and decelerating inflation than with inflation itself.

The dramatic periods of stagflation in the 1970s may now be considered historical footnotes. However, concurrent economic standstill and rising prices appear to be the new normal of economic downturns.

What Is the Cure for Stagflation?

Stagflation has no remedy. Economists agree that productivity must be enhanced to the degree where it leads to higher growth without further inflation. This would therefore allow monetary policy to be tightened to control the inflation component of stagflation.

That is easier said than done, thus the key to avoiding stagflation is for economic policymakers to take exceptional precautions.

Is Stagflation Worse than Recession?

Stagflation is typically regarded as worse than recession since it is a far more difficult economic scenario to manage. In the event of a recession, the central bank might cut interest rates to encourage borrowing and spending, so stimulating economic growth.

Is the UK Experiencing Stagflation?

A think group has warned that the UK is witnessing five years of “lost economic growth” as the possibility of stagflation approaches. According to the National Institute of Economic and Social Research, GDP will not return to 2019 levels until the second half of next year.

Does Property Do Well in Stagflation?

When the economy is stagnant and the inflation rate is high, property prices suffer. As a result, selling your property for a profit during stagflation can be tough, especially since you’ll still have to pay capital gains tax.

How Do You Survive Stagflation?

Keeping your debt to a low is one of the best methods to combat stagflation. It may be worthwhile to replace debt with floating interest rates with debt with fixed interest rate payments.

Is a Financial Crash Coming UK?

According to the Office for Budget Responsibility (OBR), the GDP will contract by 0.2% in 2023, although the UK will avoid a recession. However, the government’s independent forecaster cautioned that rising prices will reduce household income by 6% in 2023 and 2024.

In conclusion

Although the emergence of stagflation cannot be ruled out, preparing for it now and putting money aside now might spare you a lot of grief if things go rough. Monitoring your credit with Experian and remaining diligent about your overall debt now will help you improve your long-term financial health, allowing you to weather any storms that may come your way.


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