Updated Jan 29, 2022
What is stagflation?
What is stagflation?
Stagflation is a phrase used in economics to explain what happens when economic development slows or stops, unemployment is high, and the price of goods and services continues to rise at the same time.
What makes stagflation so bad? When you combine a stagnating economy with out-of-control inflation, you get a toxic concoction of economic conditions that might make everyone feel a little queasy. People not only have less money to spend, but the value of the money they do have decreases because they can't buy as much as they once could.
What Causes Stagflation
There are many ideas on why stagflation occurs and what causes it, but when you come down to it, they all boil down to two things: terrible government policies and unexpected changes in the supply of a key commodity like oil.
When the government attempts to intervene in a situation, it frequently makes matters worse. We know, it's shocking
Governments may try to boost the money supply by printing more money or making it easier to borrow money to get the economy rolling. The issue is that there may be too many dollars over there and not enough commodities, which results in fast inflation as supply cannot keep up with demand.
Stagflation could occur if the government decides to raise taxes and interest rates at the same time, potentially slowing economic development.
Another way stagflation might manifest itself is if the supply of a key product or commodity, such as oil, is unexpectedly reduced. This is also known as "supply shock," and it has the potential to cause a domino effect, resulting in a sharp surge in prices across the economy.
Producing particular commodities and transporting them from one location to another is typically more expensive due to supply limitations. Companies may raise the price of their products, lay off some staff, or do a combination of both to compensate for growing costs.
For a long time, people believed that stagflation was impossible. After all, how can prices rise if the economy is stagnant or contracting? When consumers have less money to spend, consumer demand falls... and prices usually decrease along with it. Isn't that correct?
But then came the 1970s. While disco and bell-bottom jeans were popular, a toxic confluence of events and economic reasons resulted in an era of stagflation.
This is what transpired. Oil prices rose in the early 1970s, making it more expensive to create things and transport them where they needed to go, wreaking havoc on the broader economy. Rising oil prices, combined with a series of other supply shortages, resulted in fast inflation and a global crisis, causing prices for everything from milk to gasoline to rise, up, and up, while more and more Americans lost their jobs.
The Federal Reserve attempted to address the issue by increasing the money supply and lowering interest rates. The idea was that by taking these steps, people would be able to borrow and spend money more easily, encouraging economic growth.
But there was a concern: businesses couldn't produce enough goods and services to match the increased demand, so all that more cash merely increased prices.
Businesses began laying off staff in anticipation of rising production costs. The United States suffered through a pair of harsh recessions and a period marked by "malaise" as more and more employees found their way to the unemployment line.
It wasn't until the early 1980s that the Federal Reserve, under new Chairman Paul Volcker, drastically reduced the money supply and sharply hiked interest rates in an attempt to make borrowing money more expensive for businesses and individuals and halt inflation. Those efforts first caused some short-term pain: economic production fell and unemployment rose to 10%.
But something significant happened: prices stopped growing, the economy gradually recovered, and the supply-demand balance was restored, putting an end to the era of stagflation for good.
Are We About to Enter Another Stagflationary Period?
Many economists are speculating aloud as to whether we're on the verge of a recurrence of stagflation, which hasn't occurred in over half a century.
With inflation resurfacing and the economy still recovering from the COVID-19 pandemic, it's easy to see why these concerns are surfacing. Three out of four Americans believe they've been paying higher prices for items they typically buy.
However, if you look a little closer, you'll notice that the conditions surrounding what's going on now and what happened in the early 1970s are vastly different.
Oil prices had led prices to surge at the time, throwing the entire economy into disarray. An increase in demand caused by an economy that is beginning to open up post-pandemic has sparked this current bout of inflation. This has resulted in a supply-chain bottleneck, which means things are backed up because businesses are struggling to create enough goods to fulfill demand. Most economists expect the problem will be resolved in the next year or two as production catches up.
So, while there's chance stagflation might return, it's more likely that this latest bout of inflation is very transitory and will diminish as the supply chain catches up with the rest of the economy.
How to Get Rid of Stagflation
Whether or not you believe stagflation is occurring, there are steps you can take to combat growing prices and the challenges of an economy that is stalling faster than that beat-up automobile you drove in college. Here's a quick rundown of things you can do today to help you weather the storm!
Don't be afraid.
Before you start stocking up on toilet paper (again) or buying up every bag of flour you can find at the grocery store, take some deep breaths and consider that the economy struggles from time to time. Inflation is a natural element of life's economic cycle, and hyperinflation does not persist indefinitely.
When you start listening to all of the Chicken Littles on the news and become swept up in fears of stagflation, inflation, deflation, or any other terrifying economic phrase that ends in "inflation," you may find yourself making financial decisions based on fear... and that never ends well.
Make a budget adjustment.
You do not influence how much it costs to fill up your car or buy a gallon of milk; all you can do is adjust to the realities of your circumstance. When you sit down at the dining room table with your spouse to talk about your budget at the beginning of the month, you may have to have some difficult conversations about cutting back on other areas of your budget, such as dining out or entertainment, to compensate for rising costs of essential budget items like gas and groceries.
Look for methods to control costs.
Do you have a coworker with whom you could carpool to work? Is it possible to substitute generic brands for some food items? Is there anything you can cut from your memberships or streaming services that you hardly use? It may not seem like much, but if you try to stretch your money farther, all of those modest actions can add up to significant savings over time.
Stay ahead of inflation by investing.
Inflation may affect you today, but if you don't stay ahead of it, inflation will truly hurt you 20 or 30 years down the road. How do you keep track on top of things? By investing in mutual funds, you can grow your money faster than inflation. Inflation has historically increased the price of goods and services by roughly 3% every year. The stock market, on the other hand, has an average yearly rate of return of 10–12%.
So, if you're debt-free and have a fully loaded emergency fund, it's time to start investing in high-yielding stock mutual funds that can help you prepare for retirement while also keeping you ahead of inflation!
There are numerous factors outside your control. The rate of inflation is uncontrollable. Gas prices are uncontrollable. You also have no control over whether or not stagflation occurs.
But, regardless of the state of the economy, you can decide to save and invest your money month after month, year after year, knowing that doing so will help you attain your retirement goals 10, 20, or even 30 years from now.