Stagflation: What It Is, How It Works, and How to Prepare for It

The rising prices of food and gas, the increasing rate of unemployment and layoffs, and the talks of recession are becoming the talk of the town. The massive layoff spree is one of the biggest contributors to the rising suspicions of a recession. Amid all this, a new element is emerging called stagflation. It is a relatively new term for many because people have not heard about it in a very long time.

Stagflation, however, has emerged as a result of the multiple events that are taking place and tearing through the economy. In this article, let's gain a thorough understanding of stagflation, how it works, the factors driving it, and what we can do to be prepared for it.

What is Stagflation?
How Does Stagflation Work?
Factors Driving Stagflation
How Can You Be Prepared for Stagflation?
Is It Possible to Avoid Stagflation?

What is Stagflation?

In simple terms, stagflation can be defined as an economic condition that is a result of a combination of three key elements: low or negative economic growth, high inflation (rising prices), and rising unemployment.

The term stagflation is the combination of stagnation and inflation. In the stagflation period, the effects are both inflation and a decline in the country’s GDP. The term stagflation was first used by Iain Macleod in 1965. He spoke about this term in the British Parliament. But in reality, this term was experienced by the western countries in the year 1970, when they were dependent on crude oils and faced a huge recession along with inflation. This effect causes massive unemployment and also increases costs. After 1970, stagflation never happened, but analysts comparing the pandemic and high-cost commodities with 1970 stagflation expect that it might happen again.

Stagflation happens mainly due to supply shocks, hampering the country's GDP. The main supply shock is caused by importing commodities from other countries. For example, India imports crude oil. The supply shock happens when the crude oil supply is not up to par. Due to this shortage of crude oil, the government increases the cost of fuel, and the cost barrier is faced by the common people. When this happens heavily, the usage of transportation decreases, the income to the government and to industries decreases, and some even go bankrupt. A lot of unemployment occurs; even the daily wagers lose their income, which leads to a decline in the country’s GDP and economic growth.

How Does Stagflation Work?

As mentioned above, the economic forces, i.e., slow economic growth (or stagnation), high inflation (rising prices), and rising unemployment, are what control how stagflation works. The slow or negative growth of an economy leads to a high unemployment rate, with an increased number of people going after fewer jobs, leading to lower income. Then, the increasing unemployment and inflation would ultimately reduce the purchasing power of the people.

Stagflation also harms stocks and bonds. Investors tend to suffer losses as both stocks and bonds tend to underperform.

Factors Driving Stagflation

Due to the pandemic, most countries went into lockdown for a long period causing a high supply shock of commodities to the countries and leading to cost increasing and mainly affecting the common people. Adding to this, the Russia-Ukraine war effect also caused this supply shock. The main stoppage supply shock was crude oil and cooking oil, wheat, and some fertilizers too. The effect is again an increase in the price of those commodities.

“The war in Ukraine, lockdowns in China, supply-chain disruptions, and the risk of stagflation are hammering growth. For many countries, the recession will be hard to avoid,” said World Bank President David Malpass. He even stated “Markets look forward, so it is urgent to encourage production and avoid trade restrictions. Changes in fiscal, monetary, climate and debt policy are needed to counter capital misallocation and inequality.”

Different factors are driving the current stagflation. These are:

• One of the main factors that are contributing to the current stagflation is the continuous supply shock of fuel and commodities. The pandemic adversely affected the global supply chain which has led to a shortage of semiconductors and shipping containers. This is ultimately resulting in higher prices for fuel, food, and other products, leading to high inflation.
• Another prominent factor is the rising prices of goods and services. The fiscal stimulus by governments around the world is leading to increased demand for goods and services, causing a rise in prices. Also, the supply shock is contributing to the higher prices.
• The longest continuation of monetary policies followed by some advanced economic countries is another factor contributing to the current stagflation.
• Finally, developing countries with vulnerable monetary policies are experiencing a weakening of their economic growth rate. They are especially vulnerable to the effects of broken supply chains and increasing commodity prices, which can result in higher inflation and slower economic growth.

Among emerging markets and developing economic countries, excluding China, the growth is also observed to decrease from 3.8 percent in 2022 to 2.7 percent in 2023. This reflects a weaker external demand caused by rising inflation, currency depreciation, tighter financing constraints, and further domestic headwinds.

The growth in advanced economies is also expected to slow down, from 2.5 percent in 2022 to 0.5 percent in 2023.

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How Can You Be Prepared for Stagflation?

Stagflation can be a challenging economic situation to deal with. However, there are certain steps that individuals, businesses, and governments can take to prepare for the impacts of stagflation.

Here are some ways to be prepared to face stagflation:

Diversify Your Investments

Stagflation can lead to a decline in the value of stocks and bonds, so it is important to diversify your investments to include assets that can provide a guard against inflation, such as real estate, commodities, and precious metals.

Cut Back on Spending

Another way to be prepared to face stagflation is to cut back on your spending. This can help you stretch your budget further and avoid accumulating debt.

Invest in In-Demand Skills

Stagflation can lead to high unemployment, so it is important to invest in skills that are in demand in the current job market.

Monitor Your Finances Closely

Keeping a close eye on your finances and regularly reviewing your budget and investment portfolio is extremely essential to be well-prepared to face stagflation.

Advocate for Sound Economic Policies

Governments can take steps to mitigate the impacts of stagflation by implementing sound economic policies, such as monetary and fiscal policies that balance the needs of inflation control and economic growth.

In the words of Ted Jenkin, a certified financial planner and CEO of Oxygen Financial in Atlanta, “I think it’s inevitable that we’re going to hit a recession,” he said. “Whether this is a mild recession or we go into stagflation will be the big question.”

“This is the absolute time for people to batten down the hatches and beef up the foundation of their financial house.” Jenkin added.

He told us to be prepared with at least six months of savings in the bank accounts. That might help us as emergency expenses if in case any stagflation happens also we would be safe for some while. It's better to cut down the trips and extra life costs that are unnecessary right now.

Adding to it we need to recheck the debts or credit card EMIs or any other one. It's better to clear them as soon as possible and refinance them now itself. This is because once stagflation occurs the interest rates too increase and that's a big burden then.

The best part is an investment in the growth of money by investing in good companies that gives good returns which helps even the loss of employment during a stagflationary period. Not only securing life to face the stagflation period but it's always safe having a second source of income other than employment.

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Is It Possible to Avoid Stagflation?

Avoiding stagflation is difficult because financial regulators have to balance two competing interests: inflation and unemployment. Dealing with inflation usually involves hiking interest rates, making it more expensive to borrow money that depresses consumer demand, and makes running a business more expensive. When the business is more expensive, ultimately the sales decrease because common people cannot afford such huge costs, and the employers cut down on the employees, leading to unemployment, and the remained employees have to face more burden with lower wages or salaries.

As the prices of commodities like oil, wheat, steel, and many more items rise, everything else in the economy becomes more expensive, too. One way to cut down on those prices is by deregulating those industries, more conservative economists say, but it can take months or years for those effects to reach a producer’s bottom line.

Addressing stagflation often involves dealing with inflation by raising interest rates. This can lead to a short-term sacrifice of economic growth and potentially higher unemployment, as borrowing becomes more expensive and businesses may struggle to expand. However, the rationale behind this approach is that the market tends to recover faster from unemployment than it does from persistently high consumer prices.

In the end, avoiding stagflation might not always be feasible, especially in the presence of external shocks like natural disasters or major economic crises. However, to prevent the consequences of stagflation and encourage long-term stability and prosperity, it is essential to opt for a proactive and comprehensive approach to economic policy.

Conclusion

To sum up, stagflation is a challenging economic circumstance that calls for policymakers to strike a balance between the conflicting objectives of inflation and unemployment. Although stagflation might be difficult to prevent, proactive measures like increasing supply-side factors and enacting focused fiscal policies can assist lessen its consequences.

FAQs

What is stagflation?

Stagflation can be defined as an economic condition that is a result of a combination of three key elements: low or negative economic growth, high inflation (rising prices), and rising unemployment.

How can you be prepared for stagflation?

Some ways to be prepared to face stagflation are:

• Diversify your investments
• Cut back on spending
• Invest in in-demand skills
• Monitor your finances closely
• Advocate for sound economic policies

Is it possible to avoid stagflation?

Avoiding stagflation might not always be feasible. However, to prevent its consequences and encourage long-term stability and prosperity, it is essential to opt for a proactive and comprehensive approach to economic policy.