What Is Stagflation and How Can Investors Prepare?

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Law of Supply and Demand

• Stagflation leads to rise in both unemployment and inflation so a high misery index indicates a period of stagflation.
• High inflation is more likely when the economy is strong and  surging consumer demand is driving up prices.
• “Don’t panic and do something foolish, still kind of stay the course,” Bond says.
• The misery index is the sum of the unemployment and inflation rates.
• Third, the wage-price controls that constrained supply wouldn’t even be considered today.

The bedrock of the economy, consumption is nowhere near as robust as it was in 2021, though the report suggested there’s still modest momentum. But Fed historians argue the Fed wasn’t tough enough in the ‘70s and ‘80s. What’s dangerous about those kinds of spikes, however, is that they can go on to affect other corners of the economy. When oil is more expensive, it doesn’t just become costlier to heat up homes or fill up cars with gasoline. Goods and services that require a lot of energy can also get more expensive.

This shows in 2012, the UK experienced a misery index of nearly 14% due to high unemployment and inflation. The term stagflation combines the words “stagnant” and “inflation.” Its first use is attributed to a British politician in the 1960s. Stagflation refers to an economy characterized by high inflation, low economic growth and high unemployment. A lot depends on individual circumstances, what rate you’re offered, and how long peak inflation persists. Stagflation is basically like a recession with the added headache of rising prices and costs to service debt. There’s no definitive cure so it’s harder to defeat and it can last a long time.

Blame the Loss of the Gold Standard

At the same time, it restricted supply with wage-price controls. Stagflation is a combination of stagnant economic growth, high unemployment, and high inflation. It’s an unnatural situation because inflation is not supposed to occur in a weak economy. The combination of slow growth and inflation is unusual because inflation typically rises and falls with the pace of growth. The high inflation leaves less scope for policymakers to address growth shortfalls with lower interest rates and higher public spending. A wage-price spiral seemed improbable for decades after Paul Volcker’s Fed tamed inflation in the early 1980s, bringing stagflation to an end.

Poor Economic Policies

Persistently rising price levels and falling purchasing power—i.e., inflation—are just normal conditions of good and bad economic times. Since that time, inflation has proved to be persistent even during periods of slow CM Trading or negative economic growth. In the past 50 years, every declared recession in the U.S. has seen a continuous, year-over-year rise in consumer price levels. Stagflation is a combination of economic recession (higher unemployment and less production) and inflation (higher prices). If either of those two things change, it is, by definition, no longer stagflation. Ideally, both problems would go away at the same time, with increased employment and stabilizing prices.

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You may hear Fed officials or economic experts warn of “pain ahead” as the central bank tries to get inflation under control. The reason is that their policy tools are generally meant to reduce inflation and decrease economic growth at the same time, and this can be dangerous at a time when economic growth is already negative. “At the same time, inflation reduces the purchasing power of households and consumer confidence declines, further impacting economic growth,” he says.

How did the 1970s period of stagflation end?

Some point to former President Richard Nixon’s policies, which may have led to the recession of 1970—a possible precursor to other periods of stagflation. Nixon put tariffs on imports and froze wages and prices for 90 days in an attempt to prevent prices from rising. Once the controls were relaxed, the rapid acceleration of prices led to economic chaos. The sole, partial exception to this is the lowest point of the 2008 python linear programming financial crisis—and even then the price decline was confined to energy and transportation prices while overall consumer prices other than energy continued to rise. In mid-2022, many were saying that the United States had not entered a period of stagflation, but might soon experience one, at least for a short period.

While the OAPEC lifted the embargo in March of 1974, the higher oil prices remained. The primary difference between a recession and stagflation is economic growth. A recession often indicates that an economy is shrinking or contracting and inflation rates are low. An economy in stagflation is similar to a recession but with a prolonged high inflation rate. At the time of creation, the misery index provided a lot of insight for economists, who initially believed that high unemployment and inflation rates could not occur together.

Policymakers strive to keep both down, but it is a delicate balance. Attempts to squash unemployment and boost the economy, for example through added public spending or very low interest rates, risks generating inflation. During a recession, policymakers can turn to expansionary monetary and fiscal policies to stimulate the economy, but these same policies exacerbate the inflationary side of stagflation. And since inflation is generally experienced by a wider share of the public than job loss, as Steven Wieting, chief investment strategist at Citi Global Wealth Investments, points out, this can lead to a great deal of hurt. Most consumers don’t feel there is ‘growth’ of 7.1% because real wages have been squeezed by rising prices. Therefore, it may feel like stagflation to many consumers even it economic stats don’t show classic stagflation.