Inflation vs Stagflation: What’s the Difference?

The Fed moved to keep unemployment low and boost overall demand for products and services in the 1960s. However, the unnaturally low unemployment during the decade triggered something called a wage-price spiral. The combination of slow growth and inflation is unusual because inflation typically rises and falls with the pace of growth. forex trading secrets The high inflation leaves less scope for policymakers to address growth shortfalls with lower interest rates and higher public spending. The only difference between inflation and stagflation is economic growth. Typically, inflation is coupled with economic growth and can even be a byproduct of a rapidly expanding economy.

Notably, although energy costs remain important for industrialized countries, they matter less now than they used to. In the U.S., every dollar of economic output takes 70% less petroleum to produce than it did in the ’70s. In its strictest sense, stagflation refers to a stretch of rising unemployment coupled with sharply increasing prices. Purchasing power measures the value of a currency in terms of the goods and services a unit of that currency can buy. Inflation decreases the number of goods or services you can purchase for a set amount of money, lowering purchasing power. The misery index is the sum of the unemployment and inflation rates.

  1. Nixon put tariffs on imports and froze wages and prices for 90 days in an attempt to prevent prices from rising.
  2. Between 1973 and 1975, the nation’s unemployment rate doubled to 9%.
  3. Supply-side economists blame high taxes, excessive regulation of businesses, and a persistent welfare state that enables people to survive without working.
  4. Demand-pull inflation happens when demand for goods and services rises above the economy’s capacity to meet it.

Get advice on achieving your financial goals and stay up to date on the day’s top financial stories. Conversely, if the Fed wants to combat inflation, it typically raises the Federal Funds Rate. McMillan says that paying attention to both the underlying data and the headlines is important. This decision removed commodity backing for the currency and put the U.S. dollar and most other world currencies on a fiat basis, ending most practical constraints on monetary expansion and currency devaluation.

Is Australia Heading For Stagflation?

According to the supply-shock theory, the sudden decrease in the supply of a commodity or service will usually lead to stagflation. This triggers an increase in prices, which cuts down profit margins for companies and eventually slows down economic growth. For instance, a sudden decrease in oil supply causes its price to rise sharply.

Attempts to squash unemployment and boost the economy, for example through added public spending or very low interest rates, risks generating inflation. 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. Severe supply constraints and labor shortages during the COVID-19 pandemic pushed inflation as high as 9%. Russia’s invasion of Ukraine and—in a repeat of history—production cuts by OPEC kept oil and fuel prices high. In economics, stagflation or recession-inflation is a situation in which the inflation rate is high or increasing, the economic growth rate slows, and unemployment remains steadily high.

Excess demand

During that time, America was experiencing crushing double-digit inflation, but not because the economy was expanding — quite the opposite. Soaring fuel costs sent the price of everything up just as the economy was contracting and more people were out of work, which most of the era’s economists simply didn’t believe could happen at the same time. They worried that the Fed’s expansive monetary policies, used to rescue the economy from the 2008 financial crisis, would cause inflation. When weighing big purchasing decisions—like a car, for example—consider whether you can defer or delay the purchase of items where prices may be temporarily elevated, he adds.

What Is Stagflation?

McMillan argues that based on the 1970s definition, the U.S. could have experienced stagflation—there was a supply shock caused by pandemic-related supply chain issues and a significant increase in the money supply due to the Fed’s policies. In the decades since, there hasn’t been a time when those three factors—high inflation, slow economic growth, and a rapid rise in unemployment—occurred simultaneously and for a prolonged period. In general, the stage is set for stagflation when a supply shock occurs.

There is no real consensus among economists about the causes of stagflation. They have put forth several arguments to explain how it occurs, even though it was once considered impossible. The economic theories that dominated academic and policy circles for much of the 20th century ruled it out of their models. In particular, the economic theory of the Phillips Curve, which developed in the context of Keynesian economics, portrayed macroeconomic policy as a trade-off between unemployment and inflation.

According to this theory, periods of mergers and acquisitions oscillate with periods of stagflation. When mergers and acquisitions are no longer politically feasible (governments clamp down with anti-monopoly rules), stagflation is used as an alternative to have higher relative profit than the competition. With increasing mergers and acquisitions, the power to implement stagflation increases. Last year saw big crowds, congested highways and full airplanes as tens of millions of Americans celebrated their own liberation from the pandemic. There were worries that creeping inflation would keep people home as the price of gas, meat and just about everything else ticked up — but the pessimists would not be vindicated.

After the frenzy of the pandemic era, the NFT market began to show signs of strain, leading to a significant downturn. The NFT market experienced exponential growth, with sales reaching billions of dollars. It expanded into various sectors, including music, gaming, and even real estate in virtual worlds. Whether or not we are headed for another bout of stagflation remains to be seen. Even in the absence of that label, 2022 has been a difficult year for investors, both in Australia and overseas.

Some inflation is natural and inevitable, but too much can be harmful because when consumers can no longer afford to buy the things they once could, the national standard of living declines, and the economy declines right along with it. The crisis occurred when the United Kingdom tried to redeem $3 billion for gold. The United States didn’t have that much gold in its reserves at Fort Knox. That sent the price of the precious metal skyrocketing and the value of the dollar plummeting which sent import prices up even more. In 2008, the Zimbabwean government printed so much money it went beyond stagflation and turned into hyperinflation.

In America, unemployment stood below 4% on the eve of the pandemic, with inflation also low. That suggests the current rate of unemployment at 3.6% is close to the long-term norm. Central banks in both America and Europe are struggling to deal with inflation. Stagflation occurs at the intersection of rising prices and slowing economic growth. The effects of this phenomenon are extremely damaging, from the erosion of consumer income and savings to a reduction in business output.

Inflation is the broad rise in the price of goods and services across the economy. The Federal Reserve deems annual inflation averaging 2% over the long run most consistent with its mandates of stable prices and maximum employment because that keeps the much more dangerous deflation at bay while supporting economic growth. For example, if inflation is at 5% and you currently spend $100 per week on food, the following year you would need to spend $105 for the same groceries. Turning the current inflation problem into stagflation would require two further ingredients. First, inflation would have to become persistent, so that the economy adjusts to accept and expect a higher rate of inflation each year.

For the longest time, people thought stagflation wasn’t really possible. After all, how can prices go up if the economy was stalled or even shrinking? In an effort to get a slow economy moving, the government might try to increase the money supply by printing more money or by making it easier to borrow money by lowering interest rates. But the problem is, at some point, there might be too many dollars out there and not enough goods. After successive rate increases by the Fed, the rise in consumer prices has begun to slow. The economy is just beginning to decelerate, but it continues to be very resilient.

From an investment analysis perspective, it is very useful for analyzing potential sales and earnings trends in various industries. From an economic analysis standpoint, movements in the PPI show whether the cost of producing goods is rising or falling. « Stagflation is a serious risk for investors because of its persistence, » says Michael Rosen, chief investment officer and co-founder of Angeles Investments. « That is, stagflation is rarely a transitory event and it erodes portfolio values over time, often marked by years. » Comparatively, the average length of all recessions since World War II is 11.1 months. « They don’t have that many tools to fix the supply-chain problems. But that means the demand adjustments need to be even harder, » Spatt said. « I think we’re going to see higher interest rates to reduce demand — reduce demand by companies, reduce demand by consumers. »