Before you can understand stagflation, you must first understand what inflation is. Inflation is an upward and continuous rise in the price level as a result of a decrease in the value of money.
What is stagflation? Stagflation is a term that combines the words stagnation and inflation, a condition in which slowing economic growth (stagnation), rising prices (inflation), and high unemployment occur at the same time.
What causes stagflation? The most common reason for stagflation is bad monetary policies: stagflation is a big problem for policymakers because the central bank can raise interest rates to reduce inflation or lower interest rates to increase investments and projects and hence reduce unemployment.
What is the difference between stagflation and inflation? Inflation is a component of stagflation. Stagflation has three components: a decrease in economic growth (stagnation), an increase in inflation, and an increase in unemployment.
Is stagflation different from a recession? Yes, one aspect of stagflation is low or stagnant growth in economic output, whereas in a recession, economic output declines.
Why are we at risk of stagflation? Egypt and the global economy are witnessing rates of inflation not seen in decades. The price hike was largely caused by disruptions in the supply of goods. The pandemic has forced factories to close for weeks or months at a time, a problem that continues to plague the world’s largest manufacturer, China, where strict lockdowns to prevent the spread of infection have kept ports and manufacturing facilities from operating as normal.
The Russian invasion of Ukraine exacerbated the problem further, as it disrupted Russia’s oil and gas exports and increased global energy prices. Russia’s blockade of grain exports from Ukraine, one of the world’s largest wheat producers, has also sent food prices soaring globally and raised concerns about hunger in the developing world.
Is it possible to avoid stagflation? Avoiding stagflation is difficult because financial regulators have to balance two competing interests: inflation and unemployment. Inflation is usually dealt with by raising interest rates, which makes it more expensive to borrow money. This lowers consumer demand and makes it more expensive to run a business. Employers often respond by reducing employment, resulting in a higher unemployment rate.
Conversely, central banks can reduce unemployment by lowering interest rates, incentivizing employers to make large investments, hire, and take on market risks. But when employers hire, wages go up. When wages rise, consumer prices (i.e. inflation) rise. So regulators are mostly stuck when it comes to stagflation.
The conventional wisdom to solve stagflation is to deal with inflation by raising rates and sacrificing economic growth and high unemployment. The rationale is that the market recovers faster from unemployment than from continued high consumer prices.
Has stagflation occurred before? Yes. It happened from 1973 to the early ’80s. Commodity prices were high when OPEC, a group of oil-producing countries, cut off exports to Western countries because of its support for Israel, which led to a dangerous mix of economic factors. Oil prices increased by 300% in just one year. Other commodity prices also jumped. Employers responded to the price shocks by reducing their workforce, which led to higher unemployment rates.
What happens if stagflation continues? In developed markets such as the United States, the eurozone, and Japan, this will mean tough times for consumers and periods when hundreds of thousands of people are likely to lose their jobs. But in the period after a recession, wages will be higher — wage growth that tracks inflation generally continues after inflation has subsided — and investments will stabilize and employers will be hiring again.
The real long-term danger is in emerging and developing economies, such as Brazil, Russia, India, China and South Africa. They are all large exporters whose markets depend on importing countries to sustain growth. If the economy contracts – especially the Western consumer economy – developing countries will have fewer places to send their stuff. These economies also depend heavily on foreign investment, but if international markets are in turmoil, companies are more likely to pull out of developing countries whose economies are more vulnerable. This could lead to credit crises in developing market countries that could derail the global financial recovery.
This was not written by Thndr and this is not investment advice, you should do your own research before making investment decisions.