Understanding the difference between stagflation vs. inflation is crucial.
These two economic phenomena involve rising prices and can have a major impact on businesses and consumers.
While these terms are often confused, they refer to two very different things.
But, what is the difference between inflation vs. stagflation?
What does it mean for you as a consumer?
There are some critical differences between the two that we will address in this article.
|Table of contents|
|1. What is inflation?|
|2. What is stagflation?|
|3. Inflation vs. stagflation: key differences|
|4. Other types of inflation|
|5. Frequently asked questions|
Inflation is an increase in an economy’s overall price of goods and services. At low, steady rates, inflation can produce low unemployment rates and healthy interest rates.
There are two main types of inflation to consider:
- Demand-pull inflation. Demand rises, but supply stays the same
- Cost-push inflation. Production costs rise, increasing product costs which leads to higher prices.
Historically, inflation is ever-present. This means that it is constantly happening, no matter the economic climate.
Although, inflation is higher or lower depending on economic and social factors. An example of a time of high inflation is “The Great Inflation,” which lasted from 1965 to 1982.
To recover from inflation, a country has to get to the root of the problem.
If inflation is developing due to high demand, the government may need to:
- increase taxes
- cut spending
- put in place exchange rate policies
Central banks use a variety of tools to try to keep inflation under control. For example, interest rates and monetary policy.
If inflation is developing due to high production costs, the government may need to:
- put in place price controls
- practice monetarism
Hedging against inflation can help keep your money safe and valuable.
Causes and effects
There are two leading causes of inflation:
- Consumer demand exceeds supply
- The money supply grows faster than the country’s gross domestic product (GDP)
Inflation can have both positive and negative effects on an economy.
Inflation can cause the prices of goods and services to increase. This can lead to a decrease in purchasing power.
It can also lead to higher interest rates, impacting both businesses and consumers.
Finally, inflation can also result in lower wages for workers as companies attempt to offset rising prices.
Inflation can encourage spending and investment. Why? People expect prices to continue to rise in the future.
Inflation impacts businesses and individuals. Some of those who experience the most loss are those who:
- have credit cards (especially with variable interest rates)
- live on a fixed income
- hold long-term bonds
- have a variable-rate mortgage
Stagflation occurs when high inflation combines with stagnant economic growth. Hence, the combined term of stagflation (stagnation+inflation).
Stagflation is a specific situation that can occur during times of inflation.
Historically, stagflation lasts months at a time rather than years at a time. However, the COVID-19 pandemic has changed how stagflation behaves.
More recently, the United States has experienced a prolonged state of stagflation. It has only become worse with the war on Ukraine and other social issues.
In 2021, the United States experienced an inflation rate of 4.7%. Due to unemployment rates and a slowing economy, many people called it a stagflation.
There are a few solutions government has to fight stagflation:
- Adjust monetary policy. Either to reduce inflation by inducing higher interest rates or to increase economic growth by lowering interest rates.
- Reduce the country’s dependency on oil. Rising oil prices are contributing to increasing stagflation).
- Increase productivity.
It’s important to note that we cannot treat inflations and recessions at the same time. So if a country is going to respond to stagflation, it needs to determine what the most important goals are.
Causes and effects
Economic stagnation may occur along with any of the following:
- Rising prices
- High unemployment rates
- Increasing interest rates
- Slow or negative economic growth
Stagflation often happens when the government attempts a more aggressive monetary and fiscal policy during times of inflation. This leads to rising interest rates, which slows the economy.
Stagflation can also occur if there are supply shocks (when there is a low supply of various products).
Some of the main effects of stagflation are:
- A decrease in economic growth
- Higher unemployment rates
- An increase in inflation rates
- A reduction in purchasing power for consumers
- An increase in interest rates
- A decrease in business and investment activity.
The slow growth of the economy causes an increase in the unemployment rate, which decreases spending.
During times of stagflation, both employees and employers suffer:
- Employees may lose their jobs
- Employees may incur lower wages
- Businesses may have higher production prices
- Companies may have fewer sales
- Investors may lose money they’ve put into businesses
Stagflation vs. Inflation: Key Differences
Here are the fundamental differences between inflation and stagflation.
While prices may increase in both cases, they cause very different economic situations.
Other Types of Inflation
Along with inflation and stagflation, there are other types of inflation to consider.
Deflation is the opposite of inflation. It refers to an economic state in which the price of goods and services decreases. This occurs when there is a decrease in the money supply.
Deflation may lead to more savings, but it also decreases spending, which weakens the economy. This lasts for a few months at a time since inflation is more common and preferred.
To recover from deflation, a country would need to increase government spending, cut tax rates, and lower bank reserve limits. These all encourage consumers to begin buying again.
Hyperinflation is an extreme state of high inflation. This causes very high prices and severe currency devaluation.
There are two primary causes of hyperinflation:
- An increase in the monetary supply that’s not matched with economic growth
- Demand-pull inflation
Hyperinflation can ruin an economy. Essential goods will become so expensive that consumers will begin hoarding them. Even those who are saving will lose money as cash loses its value.
This economic state can last for years.
Recovering from hyperinflation involves cutting government spending and altering the current basis.
Reflation denotes a period of economic recovery. This occurs when a country tries to increase economic stimulation while decreasing the unemployment rate to prevent or reverse deflation.
In response, there may be stimulus payments, tax cuts, and interest rate reductions.
Reflation stimulates the economy, leading to many changes:
- Increasing prices
- Increasing wages
- Decreasing unemployment rate
- Increasing gross domestic product
Reflation continues until the government reaches its goal inflation rate. This may take months or years, depending on the inflation rate before the introduction of reflation.
Keep in mind that inflation is normal, so reaching this goal (as long as it’s in control) can be positive for the economy.
What are the 5 different types of inflation?
The types are stagflation, inflation, deflation, hyperinflation, and reflation.
Why is stagflation so unpopular?
Stagflation combines three negative occurrences:
It marks an unhealthy economy that involves higher prices without any growth.
What is the misery index, and how does it relate to stagflation?
The misery index measures the amount of economic distress that everyday people feel. It tells economists how the average citizen is doing in the current economy.
Experts calculate the misery index by adding the seasonally-adjusted unemployment rate to the annual inflation rate.
The misery index is a rough estimation of a country’s propensity to slide into stagflation. Since it accounts for the unemployment and inflation rates, the misery index directly relates to stagflation.
What is purchasing power?
Purchasing power explains how valuable a currency is. Experts express purchasing power as the number of goods or services that one unit of the currency can buy.
High purchasing power means that you can get more things for less money. Likewise, low purchasing power means you will need to pay more for fewer things.
Does inflation increase during stagflation?
Stagflation can occur whether inflation rates are high or low. The determining factor is whether the economy is growing.
If the economy is growing well, there is inflation. If it’s slow, there is stagflation.
The number one marker for a slow economy is a high unemployment rate. So with stagflation, you’ll see periods of high unemployment, causing a decrease in spending.
What is the difference between stagflation vs. recession?
Stagflation refers to prolonged slow growth of the economy in conjunction with inflation. A recession is a regular economic phenomenon that refers to a short period of a slowing economy with a rise in unemployment.
You can prepare for a recession better than you can prepare for stagflation. Why? Because you know recessions will keep coming with each economic turn.
Recessions may be discouraging, but they’re a crucial part of the economic cycle. There have to be downturns to balance the upturns.
You should invest in a recession to take advantage of the economic turn.
What is the difference between inflation vs. deflation?
Inflation and deflation are opposites.
Inflation refers to increasing prices. On the other hand, deflation refers to decreasing prices.
Inflation occurs whenever the change in the price of goods and services is greater than zero. Conversely, deflation occurs whenever this percentage is lower than zero.
What is the difference between inflation vs. hyperinflation?
Both inflation and hyperinflation refer to an increase in prices. However, hyperinflation is an out-of-control version of inflation.
Hyperinflation refers to economic situations in which the rise in prices exceeds more than 50% per month. Inflation refers to any other situation in which prices are rising.
What is the difference between stagflation vs. deflation?
Stagflation refers to periods of high inflation and slower economic growth. During this time, the prices of goods and services are rising.
Deflation refers to a period of decreasing prices. Deflation is the opposite of inflation.