A potential and long-term risk for the world economy can be described in just one word — and no, it is not recession. It will be stagflation!
According to the SIFMA Mid-Year 2022 Survey, 80% of economists named stagflation as the greater long-term risk to the economy. The next biggest risk they identified was deflation, with 13% of respondents. Stagflation is by far and away the most popular description of what the economic backdrop will be in the next 12 months, according to the recent Bank of America global fund manager survey.
So, what is stagflation? Why do people fear it? How will it affect our lives? How will this change the world? Let’s all find out in this article.
Defining Stagflation
Stagflation is a combination of the words “stagnation” and “inflation.” It describes an economic condition characterized by slow growth and high unemployment (economic stagnation) mixed with rising prices (inflation).
The term first appeared as early as 1965, when British Conservative Party politician Iain Macleod in a speech to the House of Commons said: “We now have the worst of both worlds — not just inflation on the one side or stagnation on the other, but both of them together. We have a sort of ‘stagflation’ situation and history in modern terms is indeed being made.”
Initially, many economists believed stagflation wasn’t possible. After all, unemployment and inflation rates generally move in opposite directions. However, as the “Great Inflation” period of the 1970s ultimately proved, stagflation is real, and it can have a devastating effect on the economy.
In mid-2022, many believed that the United States had yet to enter a period of stagflation, but might soon experience one, at least for a short period. In June 2022, Forbes magazine argued that a period of stagflation was likely because economic policymakers would tackle unemployment first, leaving inflation to be dealt with later.
Stagflation vs. Inflation
Though stagflation and inflation are related, they shouldn’t be confused. The term inflation refers to a sustained increase in the average price level of all goods and services, not just a few of them, in an economy over time. Inflation happens when the money supply grows at a faster rate than the economy can produce goods and services.
On the other hand, stagflation happens when inflation exists in tandem with slow economic growth and high unemployment. Typically, these economic conditions don’t occur together. Unemployment and inflation tend to be inversely correlated. So, as unemployment rates increase, inflation usually decreases and vice versa. Of course, as the stagflation of the 1970s illustrated, this relationship isn’t always stable or predictable.
What causes Stagflation?
Economists look back at past examples of stagflation for insight into the factors that can lead up to such an event. Although there is no real consensus about its causes, some of the key triggers include:
- Rising oil prices: An increase in gas prices, which consumers experienced in the late 1970s and early 1980s and more recently in 2021 and 2022, leaves less room in people’s budgets for discretionary spending and can increase the reliance on debt.
- Supply shocks: When changes occur in the availability of a product, the price usually increases or decreases. This can put a lot of strain on consumer wallets, especially if prices are increasing on necessities, such as food.
- Poor economic policy: Creating a policy that makes production costlier and less profitable while growing the money supply too quickly could have repercussions on supply and, as a result, the price of goods.
Why do people worry about Stagflation?
People are more financially stable when the economy is booming and prices and unemployment are low. But lately, the global economy has experienced inflation rates not seen in a very long time — due to wars, disruption of oil supply, unemployment, plus the recent pandemic — leading some to warn of possible impending stagflation.
Many economists are optimistic that 2022 would be a period of strong economic growth as businesses reopened their doors after the pandemic and consumers spent their accumulated savings. But reality has brought rising inflation rates that have exceeded all predictions, and slow economic growth that has led to an increase in economic distress even with encouraging economic signs.
When high inflation and the fear of a recession occur in combination, the increased cost of goods and the fear of joblessness can put tremendous pressure on consumers. This may cause many to put off spending on certain items, further increasing the risk of stagflation and potentially worsening the general economy’s health.
How to prepare for Stagflation?
It’s difficult to predict how the recession or stagflation will affect your finances. As the saying goes, better safe than sorry, so here are tips on how you can start building financial resilience against stagflation.
1. Maintain a good credit
Paying your debts on time and avoiding carrying credit card balances on your new billing cycle are the best ways to maintain a good credit. Good credit helps a lot once an emergency happens and you are short on funds, as this will likely allow you to qualify for a loan or other funding options.
2. Manage your spendings wisely
Needs should always come first before wants. This practice helps you save more which you can use during uncertain times. Plan your monthly expenses ahead of time and make sure to include emergency funds on your budget.
3. A solid emergency fund
A good rule of thumb when building an emergency fund is that it should be worth at least six (6) months of your current living expenses. Consider setting a savings goal, moving money from one account into savings automatically, or using a savings-focused application.
4. Additional sources of income
Being creative on how you spend your money can lead to an additional income stream. A side gig, renting out your house while you’re away, driving for Uber for a few hours a day, or even just simply using a cash back credit card that allows you to earn while using it goes a long way in preparing you for the worst financial situations.
Final Thoughts
Although stagflation is still full of uncertainty as to when it will happen and the impact it will cause to the global economy, preparing for it now and setting some money aside today can save you a lot of headaches if times do get tough.
Economists are closely watching the trends in growth, unemployment, and inflation along with the potential catalysts that could trigger stagflation including supply disruptions and central bank policies. Persistently high energy prices have caused particular concern among some.
