Stagflation

What Is Stagflation?

Stagflation is a word feared by most central banks. This term refers to a toxic combination of rising unemployment and negative gross domestic product (GDP) which creates economic stagnation.
Furthermore, — unlike what happens in a recession, where businesses overlap, manufacturing output declines, and demand, and subsequently, prices, fall — stagflationary environments likewise come with increased prices and high levels of inflation, creating an especially troublesome problem to solve.
While central banks have some tools at their disposal to combat stagflation — or even better, to prevent their economy from becoming mired in it altogether — there are some stocks that outperform even through such unforgiving conditions. We'll get more into them below.

How Does Stagflation Occur? What Befalls the Economy?

The phrase "stagflation" is a creative mix of "stagnation" and "inflation" first uttered by British politician Ian Macleod during the 1960s. Students of economic theory had long thought this occurrence improbable, primarily because unemployment and inflation tend to move inversely: When unemployment is high, prices typically decline because demand lessens, and vice versa.
However, it can and does happen.

Stagflation Example: The U.S. during the 1970s

Stagflation occurred in the United States during the 1970s as a result of rising unemployment, slow economic growth, and an oil crisis. Truth be told, one might say that a significant part of the 1970s and early 1980s were a time of recession. Unrest in the Middle East led the United States to supply arms to Israel, which angered the Arab nations of OPEC, the Organization of Oil Exporting Countries. OPEC controlled more than half of the world's oil supply, and as a result of the intervention, they punished the U.S. as well as other nations by imposing a embargo, effectively prohibiting oil exports as well as restricting oil production.
The oil embargo caused severe supply shortages, and prices skyrocketed on demand. The embargo was not lifted until 1974, when the United States convinced Israel to pull out troops from the Sinai Peninsula, albeit the subsequent Iranian Revolution in 1979 created further disruptions in the oil supply once more.
Economic theorists, particularly those who followed the teachings of John Maynard Keys, believed that in this scenario, rising oil prices should really drive economic growth. In any case, this didn't happen. The Federal Reserve tried numerous strategies to combat stagflation, however pundits believe that little helped because there was excess liquidity in the markets, fundamentally permitting room at costs to continue to rise. It took until 1979, when Fed Chair Paul Volcker increased interest rates to double digits to quell the rampant inflation.

What Causes Stagflation?

Sluggish economic growth and rising unemployment set the scene for stagflation, yet it takes an extra ingredient, for example, a supply shock, to fan the flames. Supply shocks are unexpected events that cause major disruptions in a supply chain, like a war, a natural disaster, or, in contemporary times, the global COVID-19 pandemic. The Federal Reserve even published papers detailing how it recalibrated fiscal policy in response to this supply shock by injecting liquidity into the markets and lowering interest rates.

What Are the Effects of Stagflation?

Nobody ought to be surprised to hear that living through stagflation is a pretty miserable experience. As a matter of fact, economists even created the misery index as a method for measuring the level of distress an average person feels economically. This rate is calculated by adding the seasonally adjusted employment rate to the inflation rate. The highest misery index ever measured was during Ronald Reagan's initial term.

How Do You Combat Stagflation? Why Is It So Hard to Fix?

Central banks for the most part have to fight inflation or slow growth, not both at the same time. When this happens, they typically have to choose the greater evil to zero in on first. After the primary wave of the COVID-19 pandemic, the Federal Reserve began a series of quantitative easing measures designed to increase liquidity and spur growth, for the most part through increased credit and lending. Now that it seems that inflation is here to remain, many believe the Fed will be bringing interest rates up in order to attack it — at the temporary expense of economic growth.

How Could You Invest During Stagflation? Which Stocks Do Well?

Typically, the stocks that benefit from inflation likewise well in stagflationary environments. These include value stocks, whose share prices trade lower than their true worth, or intrinsic value. Investors use metrics like price-to-earnings ratios (P/E Ratios) to determine a stock's relative value.

How Does Stagflation Differ From Other Types of Inflation?

There are a wide range of types of inflation, and each has unique characteristics and implications that set it apart from the others. Explore the glossary below to learn what defines each type of inflationary environment.

Glossary of Inflation-Related Terms

• Deflation, the opposite of inflation, happens when the prices of goods and services decline, for the most part due to changes in monetary supply. On the upside, consumer purchasing power increases (i.e., consumers "get more for their dollar"), in spite of the fact that it must likewise be noted that deflation generally flags a stoppage in the economy.
• Disinflation, totally unrelated to deflation, simply means that inflation is increasing at a slower rate than previously expected. For example, in the event that the month to month CPI was measured at a 4.2% annual rate in June and 3% in July, prices disinflated by 1.2% — yet are as yet increasing at a 3% annual rate.
• Hyperinflation is inflation that is out of this world high regardless accelerating. We are talking rates of 1,000%+. Hyperinflation cripplingly affects an economy and can crash a currency. In Hungary after World War II, the rate of hyperinflation was so terrible the government needed to print a 100 quintillion dollar bill, making it the highest denomination ever issued.
• Stagflation is a toxic combination of high inflation, high unemployment, little to no economic growth, and a supply shock.

Are We Experiencing Stagflation?

As indicated by a video by Blu Putnam and Erik Norland of CME Group, "with prices rising and numerous uncertainties facing the U.S. economy, the risks of stagflation — that is, 1970s-like elevated inflation with slow growth or even a recession — are rising."

Highlights

• Since the 1970s, rising price levels during periods of slow or negative economic growth have become somewhat of the standard rather than an exceptional situation.
• Stagflation was first recognized during the 1970s when many developed economies experienced rapid inflation and high unemployment as a result of an oil shock.
• The prevailing economic theory at the time couldn't easily explain how stagflation could happen.
• Stagflation refers to an economy that is experiencing a simultaneous increase in inflation and stagnation of economic output.

FAQ

What Is an Example of Stagflation?

An example of stagflation is when a government prints currency (which would increase the money supply and create inflation), while increasing government rates (which would slow economic growth) — resulting in stagflation.

Why Is Stagflation Bad?

Stagflation is a logical inconsistency as sluggish economic growth would likely lead to an increase in unemployment however shouldn't result in rising prices. For this reason this phenomenon is considered terrible — an increase in the unemployment level results in a decrease in consumer spending power. In the event that you tack on runaway inflation, that means that what money consumers in all actuality do have is losing value as time goes by — there is less money to spend and the value of the money is in decline.

What Causes Stagflation?

Stagflation is characterized by sluggish economic growth and relatively high unemployment — or economic stagnation — which is at the same time accompanied by rising prices (i.e., inflation). Generally, stagflation happens when the money supply is expanding while supply is being constrained.

What Is the Cure for Stagflation?

There is no definitive cure for stagflation. The consensus among economists is that productivity must be increased to the point where it would lead to higher growth without extra inflation. This would then consider the tightening of monetary policy to rein in the inflation component of stagflation (that is easier said than done, so the key to preventing stagflation is to be extremely proactive in keeping away from it).