Stagflation Defined: Causes and Effects, and How To Prepare

Camino Financial09 Jan 2024
Stagflation Defined: Causes and Effects, and How To Prepare
Stagflation is a combination of rising inflation and economic stagnation. To better understand this economic phenomenon, let's dive into it and how you can protect yourself against it.
Table of Contents
1. What is stagflation?
2. What causes stagflation?
3. Effects of stagflation
4. Differences between stagflation vs. Inflation
5. How to prepare for a stagflation

What Is Stagflation?

Stagflation is when an economy is experiencing both high inflation and low growth. This can happen for different reasons, and the result is that consumers experience lower incomes and higher costs of living. Stagflation is a combination of rising inflation and economic stagnation. It's when an economy is experiencing both a higher than average unemployment rate and rising prices for goods and services. This has been occurring around the world since 2012, when prices began increasing rapidly due to higher oil prices, weaker currencies (like the euro) against foreign currencies (such as US dollars), and government policies such as quantitative easing (QE), and other factors.

How Can Government Prevent Stagflation?

There are several ways in which they can avoid or mitigate economic stagflation:
  • Reduce debt levels through austerity measures
  • Increase productivity through improvements in technology
  • Use monetary policy tools like QE to increase aggregate demand
There are many different economic arguments about which method to use. We will no doubt see these debates play out during the mid-terms and the 2024 Presidential Election.

Are We in Stagflation?

Stagflation is a risk now for some people and some industries. This affects countries, regions, and companies as well. Understanding stagflation and how it relates to you is important because it can help you make smart decisions about your money and investments. Many factors can contribute to stagflation. But in general, high inflation and unemployment usually signal the start of a cycle.

How Does Stagflation Start?

The primary driver of stagflation is the combination of high inflation and stagnant growth. Stagflation can occur when there's a decrease in demand for goods, which leads to a decline in production. A supply shock could cause this, such as an increase in oil prices or a decrease in productivity due to bad weather conditions. When this happens, and businesses can't sell their products, they'll have no choice but to reduce costs by laying off workers or reducing wages (or both). This results in lower economic output because fewer people are working and purchasing goods: you end up with both low employment and low GDP growth at the same time.

Is It Possible to Avoid Stagflation?

The Federal Reserve and other central banks have many tools to help prevent stagflation. The first step is to prevent inflation from occurring in the first place. Lowering interest rates, increasing supply and demand, or stimulating the economy, can be a way to achieve it. The second step is to take action as soon as inflation starts occurring. To do this, the central bank needs to keep a close eye on measures of consumer price inflation such as CPI (consumer price index).

Has Stagflation Happened Before?

Stagflation is a rare economic phenomenon, so it's hard to say whether or not stagflation can happen again in the future. However, some economists believe it is more likely due to the current global economy and its reliance on fossil fuels. This means that if we continue down our current path, we'll see more oil shortages and inflation as long as everything continues running smoothly. But you could also see a major economic downturn when something goes wrong. On a personal level, you can avoid it by careful management of your own finances.

When Did Stagflation Occur?

The term stagflation in the 1970s was first used to describe the economic downturn—the term has been revived because of its relevance to today's economy. This makes it difficult for companies to profit and spend money on consumers. This was a problem that plagued many countries during this time period, including the United States, Great Britain, and the Netherlands.

What Happens to the Economy During Stagflation?

The economy is usually the first to suffer when inflation and unemployment rise. Inflation causes prices to increase, meaning you have less money in your pocket. The cost of goods and services will also go up, making it difficult for people to afford basic necessities like food and clothing. Unemployment also increases during stagflation because companies will lay off workers to cut costs because they can't afford higher production costs due to inflation. If stagflation goes on long enough, it can lead to economic recession or depression. We can define a recession as two consecutive quarters of negative GDP growth. Once that happens, economists consider a country at risk of entering into a depression (when GDP continues its downward slide).

What Causes Stagflation?

The reality is the extraordinary financial measures introduced during the 2020 pandemic crisis caused the stagflation we are seeing today. Stagflation occurred by several economic factors. However, the government caused these too by the rising borrowing and debt due to the pandemic. The main reasons are:
  • Inflation is a rise in the general level of prices.
  • A recession is a decline in the general level of activity
  • Stagflation is a combination of inflation and recession
All of this occurs when an economy enters a period of sustained unemployment, high rates of inflation, and low growth levels. When there is a decrease in demand for goods and services, which can be caused by recession or when people have less money to spend, this will cause prices to go down (deflation), but at the same time, companies will lay off workers, which will increase unemployment and reduce wages (stagnation). So you end up with lower prices and less spending, combined with high unemployment and stagnant wages. An increase in the cost of oil or other commodities can also lead to stagflation because it increases production costs for companies and increases consumer prices.

What are the interest rates during the stagflation?

Interest rates usually rise during periods of stagflation as central banks attempt to control inflation. The exact interest rates during any given period of stagflation will depend on the policies of the central bank and the severity of the economic conditions.

Effects of Stagflation

Some effects are from having less money to spend to struggling with unemployment. It can also stop you from finding a new job. Economic recessions can make people feel discouraged and depressed. Stagflation is similar to this experience in many ways—and it's not just because of how the economy feels. These two conditions share some telltale signs that you may notice in your daily life: high unemployment rates, low productivity levels, high inflation rates, sluggish stock markets, and slow growth of gross domestic product (GDP).

Why Is Stagflation a Risk Now, and for Whom?

The answer to this question depends on your perspective. For the government: Stagflation is a risk because it requires policy changes that are not aligned with the current administration's objectives. The current administration wants to cut taxes, but increasing inflation would increase the amount of revenue collected through sales taxes and excise taxes by hurting consumer spending power. Likewise, increasing interest rates isn't exactly in line with lowering unemployment or boosting real economic growth. For businesses, stagflation increases the cost of doing business while driving down profits at the same time. This makes it harder for companies to make money. This is because they can't raise prices without losing customers who are sensitive about paying more money for less product/service value than before also because demand for their goods isn't growing as quickly as expected due to falling consumer confidence levels caused by high inflation numbers.

Does Stagflation Cause Recession?

Stagflation is a prolonged period of high inflation and slow economic growth due to an increase in the money supply or a decrease in aggregate demand. In other words, stagflation occurs when there is either an increase in money supply or a decrease in aggregate demand. It's like adding more water to your popcorn while waiting for it to pop—you end up with a soggy mess instead of popcorn! These factors are not mutually exclusive. They often act together to create the conditions for stagflation.

Differences Between Stagflation vs. Inflation

Inflation is a rise in the general level of prices for goods and services in an economy at a higher rate than expected, and it often occurs when there's too much money in circulation or it's not evenly distributed among people. Stagflation is a combination of high inflation and low economic growth. Vary and complex are the causes of stagflation, but it typically occurs during recessions or periods of high unemployment. When demand decreases, businesses slow down production and reduce hiring new workers or giving raises/bonuses. This results in decreased demand for their products, leading them to raise their prices to maintain their profit margins. This causes other companies who rely on those manufacturers' products and consumers requiring those goods (e.g., groceries) to increase their prices accordingly. This feedback loop continues until everyone feels the pinch from higher costs but doesn't have enough money each month due to stagnant wages or unemployment benefits ending before finding another job offer.

What Is the Difference Between Stagflation and Recession?

Stagflation is the state of the economy when there is high inflation and a low or negative growth rate. It combines stagnation in economic activity (recession) and inflation. However, we must remember that stagflation is not always bad for an economy.

What Is Stagflation vs. Recession?

Stagflation is when the economy is in a recession and inflation is high. Recessions are periods of time where the economy contracts or decreases in size; they usually happen when the gross domestic product (GDP) decreases for two or more quarters in a row. Inflation is a sustained increase in the general price level of goods and services.

How to Prepare for a Stagflation

Are you worried about the possibility of stagflation? There are several things you can do to prepare:
  • Save more
  • Reduce spending on non-essential goods and services
  • Increase income by obtaining extra work
  • Reduce debt by paying off credit cards with high-interest rates
It's easy to panic in situations like this, not just inflation and stagflation. Instead, take a deep breath and work out a solid plan following those steps.

How to Fix Stagflation?

The Federal Reserve can influence the economy by changing interest rates. If the Fed raises interest rates, it makes loans more expensive, decreasing borrowing activity. This may slow down economic growth and decrease inflationary pressures in an economy. So it's not an ideal situation in the short term, but it will fix it.

Use Fiscal Policy to Reduce Inflation

Governments can use fiscal policies such as tax increases or spending cuts to reduce inflationary pressures in their respective economies by tightening the money supply. This can achieve through increased taxes on consumers and businesses. But they will then have less disposable income to spend on goods and services. This reduces aggregate demand (AD), reducing aggregate supply (AS).

Use Both Monetary and Fiscal Policy

The government should not rely solely on one tool when trying to combat its effects. It must use both tools simultaneously. This is because each one affects specific parts of the economy differently. At the same time, while still having some overlap between them which could cause unintended consequences if used separately without considering what other tools might need adjustments made accordingly.

Stagflation Causes Economic Depressions

Now you know what stagflation is. Stagflation is a phenomenon that causes an economic depression. It occurs when there is an increase in prices without a corresponding increase in output. This leads to a decrease in consumer demand and higher unemployment rates. In short, we need to avoid stagflation at all costs. In these tough times, you may need some financial help. Be sure to contact us today if you are considering a loan. Apply now!

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