Stagflation explained: why is it bad and what is the cure?
Consumers, investors and economists fear that three economic enemies – inflation, slowing demand and unemployment – will combine and form a major crisis called “stagflation” for the whole world.
Experts also say some may already be feeling the pinch of stagflation. However, this concept of stagflation is complicated because not all inflation leads to it. Here’s everything you need to know about stagflation, including how it works and how you can prepare for it.
What is stagflation?
Typically, stagflation occurs when a country’s economic growth slows, demand weakens, and unemployment rises despite rising inflation.
Because unemployment generally does not support growth, and when demand falls, so does inflation. However, this is out of the ordinary, as companies would likely abandon their investments because consumers are spending less and/or have limited amounts of money available for purchases.
Concepts like this are central to the theory called the “Phillips curve,” which shows that as unemployment falls, inflation should rise, and vice versa. But these theories would crumble under stagflationary conditions.
For instance; In the United States, unemployment and inflation rose at the same time throughout the 1970s and 1980s, which experts say was stagflation. In May 1975, unemployment reached 9%, while about six months earlier the rise in prices was 12.2% in November 1974.
Both remained high until the early 1980s, when the US Federal Reserve deliberately manufactured a recession and raised interest rates to intervene.
What causes stagflation?
Stagflation is usually caused by supply disruptions, and given the current situation in light of the Covid-19 pandemic and the Russian-Ukrainian war, this is a fundamental result. In other words, stagflation usually occurs when the money supply is growing but the supply is limited.
For instance; If a fast-spreading strain of bird flu affects a large population of chickens, a shortage could increase egg and meat prices as well as reduce production and curtail employment. This is mostly similar to current shortages of semiconductor chips which have driven up car prices due to supply constraints.
Oil Price: Some experts say that stagflation is caused when a sudden increase in the cost of oil reduces the productive capacity of an economy due to rising transportation costs and production costs. This will drive up prices even if people have been laid off.
Poor Economic Policies: Some experts also believe that inflation and the confluence of stagnation are the result of poorly designed economic policy. Harsh regulation of markets, labor and goods in an inflationary environment is cited as the possible cause of stagflation.
Why is stagflation bad?
Stagflation is a conflict in which slow economic growth leads to rising unemployment but no rising prices. This is why this stagflation is considered bad because the increase in the level of unemployment would lead to a decline in the purchasing power of consumers.
How to prepare for possible stagflation:
1. Take advantage of the current labor market strength:
Even if economic growth slows, businesses would still have a demand for workers. Take the opportunity to negotiate a raise or look for a new position. The data suggests that people who change jobs see greater salary gains.
2. Create and track a budget:
High inflation could make it crucial to assess where your money is going each month. Manage your finances, track your spending, then compare it to where prices are rising the most. Sticking strictly to a budget could help you avoid buying bloated items and free up crucial amounts of cash.
3. Plan for upcoming emergencies
Use the freed up cash to start a new emergency fund or continue to add to an existing fund. Experts recommend that accumulating at least six months of your cash expenses can serve as a cushion for a period of unemployment.
4. Consider your bear market strategy
No investor likes to take a loss, especially if that money is for retirement or a long-term goal. However, in times of high market volatility, it is important to avoid overreaction. Avoid selling and diversify your investments.
Also read: Calling the current economic situation stagflation is a misnomer: Madan Sabnavis