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It’s like one side of the seesaw can go down quite low without the other side rising very high. The U.S. appears to be on the precipice of stagflation, but the economy can change rapidly and without notice. It’s important to keep up with the news (calmly and without letting it provoke you to, say, drop an investment without heavy consideration and research) and stay flexible.
Housing remains a necessity irrespective of economic conditions, making real estate a stable investment. Rental prices consistently align with inflation, reinforcing the resilience of property as an investment choice. Governments struggle to fix stagflation by raising interest rates, which control prices but worsen unemployment. In this blog, we’ll explore what is stagflation, its impact, best-performing industries, and stagflation vs inflation.
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Achieving this balance would enable the implementation of monetary policy adjustments to curb the inflationary aspect of stagflation. If there was such a thing as good inflation, “boomflation” would be it. It is inflation that occurs while unemployment is extremely low and economic growth is especially strong. For example, much of 2021 could be characterized as a period of boomflation. The average inflation rate for the year was 4.7%, but unemployment was steadily declining and GDP grew by 5.9%. Inflation isn’t necessarily a bad thing if it takes place during a period of strong economic growth, but the combination of inflation and an otherwise weak economy creates a serious challenge from a policymaker’s perspective.
- Imagine being stuck in mud, the more you try to move, the harder it gets.
- In the 1970s, economist Arthur Okun developed an index to measure stagflation that is calculated by adding the unemployment rate to the annual inflation rate.
- Stagflation is a period of stagnant economic growth accompanied by persistently high inflation and a sharp rise in unemployment.
The Negative Impact of Stagflation
- It underscores the importance of continuous research, analysis, and adaptation in the face of economic challenges.
- “If you’re an investor, you need to play off expectations as much as reality,” he says.
- After OPEC imposed an oil embargo in 1973, energy costs surged, increasing production and transportation expenses across the economy.
- There were signs of possible stagflation during the early 2020s, but as economists and analysts know, it’s much simpler to define trends and eras in the rearview mirror than in real time.
- Central banks like the United States Federal Reserve, European Central Bank, and Bank of England typically aim for a 2% annual inflation rate.
Having said that, the general causes of stagflation seem to be a rapid increase in the money supply or an imbalance in supply and demand. For example, a rapid increase in the money supply can cause consumer demand to spike faster than supply can keep up. But, generally speaking, these are the main potential causes of stagflation. As an example, in 2008 unemployment spiked to 10% as a result of the financial crisis in the United States, but inflation was above 5% for much of that year and the economy was clearly in a recession.
British politician Iain Macleod first used the term “stagflation” in a 1965 speech to the House of Commons to describe the U.K. The term gained far wider prominence during the 1970s oil crisis when OPEC’s embargo triggered a dramatic increase in energy prices in the U.S. the only investment guide you’ll ever need and Europe. This supply shock drove up production costs across the economy while simultaneously reducing economic output. Stagflation happens when an economy faces slow or no growth (stagnation) alongside rising prices (inflation). It’s different from a standard recession or inflationary period because it combines both high inflation and high unemployment. Typically, inflation and unemployment have an inverse relationship when inflation goes up, unemployment tends to drop, and vice versa.
High-dividend stocks from companies with stable cash flows and consistent dividend-paying capabilities, including utilities, consumer staples, or REITs, generally show resilience during economic downturns. Commodities and real assets might fare better during stagflation, whilst fixed-income and defensive equities could be more suitable during a recession. The White Coat Investor is filled with posts like this, whether it’s increasing your financial literacy, showing you the best strategies on your path to financial success, or discussing the topic of mental wellness. To discover just how much The White Coat Investor can help you in your financial journey, start here to read some of our most popular posts and to see everything else WCI has to offer. And make sure to sign up for our newsletters to keep up with our newest content.
A sharp increase in interest rates solved the inflation problem but caused a deep recession. Eventually, prices stabilized and the economy recovered, but it took about a decade to fully work through the fallout. This situation prompted the involved parties to reach a disengagement agreement, leading to the lifting of the embargo in March 1974. A major supply chain disruption, commodity price shock, or aggressive trade policy could tip the balance. Still, most economists say a full stagflationary period remains unlikely without a major external shock.
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That problem is often regarded as even harder for policymakers to solve than a typical recession, as higher inflation can prevent the Federal Reserve from cutting interest rates to boost the economy. A supply shock is a sudden disruption in the supply of crucial goods or resources, leading to higher production costs. Central banks also face a difficult dilemma, making monetary policy unpredictable and leading to increased currecny volatility and a “flight to safety” towards strong currencies. Stagflation might be an economist’s nightmare, but it doesn’t have to be yours. While you can’t control inflation, interest rates, or economic policy, you can control how you respond.
During the post-pandemic inflationary period, rental property investing faced challenges. Although housing prices and average rent increased annually, eviction moratoriums in many areas prevented landlords from evicting tenants unable to pay rent. Effectively managing this extreme inflation poses challenges due to the inherent trade-offs. Tightening monetary policy to rein in inflation can inadvertently dampen economic expansion, possibly leading to escalated unemployment. During this extreme inflation, both bonds and stocks incur losses as a result of subdued stock prices from the lack of growth and the negative impact of high inflation on bonds. By withdrawing the gold standard, central banks had more control over the economy, but it also made inflation difficult to manage, adding to the Stagflation crisis.
Law of Supply and Demand
The Motley Fool reaches millions of people every month through our premium investing solutions, free guidance and market analysis on Fool.com, top-rated podcasts, and non-profit The Motley Fool Foundation. “Stagflation also poses a risk to bonds since the fixed interest rates they offer might not be high enough to offset the loss of buying power given the high rate of inflation.” This destructive combination can put households and businesses in a tight spot as incomes fail to rise as fast as prices increase, he says. “Stagflation, in that sense, is more impactful on portfolios than a one-off crisis.” When the US saw stagflation in the ’70s and ’80s, the unemployment rate peaked at about 9% in 1975, before cooling and rising to another peak of 10.8% in the early ’80s, according to the Bureau of Labor Statistics. The jobless rate in the US will keep picking up through at least the next 18 months.
Imagine being stuck in mud, the more you try to move, the harder it gets. It happens when prices rise, jobs become harder to find, and businesses slow down. Normally, when prices rise, wages increase too, but in stagflation, people struggle as costs go up while incomes stay the same or decrease. Inflation is a broad term that refers to an increase in the prices consumers pay for goods and services as defined by the Consumer Price Index, or CPI. However, the word “inflation” only describes rising prices — it doesn’t have anything to do with things such as unemployment or gross domestic product (GDP) growth.
When businesses can’t produce goods efficiently, they raise prices to cover costs, while economic growth suffers. These supply shocks followed an accommodating monetary policy by the Federal Reserve, aimed at stimulating economic growth. However, global economic expansion sharply decelerated throughout the 1970s, marked by two U.S. recessions and the onset of a third in 1980. Unemployment denotes the number of individuals actively searching for employment but encountering difficulty in securing jobs. It serves as a crucial economic indicator reflecting the well-being of the labour market. Elevated unemployment rates can have substantial social and economic ramifications, including reduced consumer spending, diminished tax revenues, and augmented government expenditure on unemployment benefits.
This leads to a vicious cycle of reduced hiring, layoffs, and even business closures. Usually, when prices go up, central banks raise interest rates to control inflation. If the government tries to create more jobs, it might cause prices to rise even higher.
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The 1970s oil crisis is a prime example, and while we may not face the exact same conditions today, there are certainly risks of stagflation in the current economic climate. To tackle stagflation, policymakers need to balance controlling inflation with fostering growth, while addressing the root causes of the economic slowdown. Stagflation is particularly troublesome because the traditional tools that address one problem typically worsen the others. This policy dilemma explains why stagflationary periods like the 1970s tend to be prolonged and difficult to resolve. At the same time, the economy deteriorated, people had less money to spend, and many lost their jobs.
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