What is stagflation? Stagflation is like an imperfect storm, a weather happening with lots of contributing factors. Stagflation is an economic condition caused by a combination of increasing inflation and high unemployment rates, which cause a decrease in consumer demand for goods and services.
In a good economy, there’s a balance, where slow steady economic growth is in step with consumer demand. With Stagflation, the economy is out of balance in a bad way.
What Does Stagflation Mean?
Stagflation occurs when high inflation happens at the same time as high unemployment. Despite recent growth in the unemployment rates, the country is still about 2 million jobs shy of employment numbers in pre-pandemic days.
The pandemic also caused problems that are contributing factors to Stagflation, such as supply chain issues. Lack of product contributes to inflation because rising prices are the result as consumers vie to purchase from an insufficient supply.
To understand Stagflation, economists look at the whole picture.
Is Stagflation a Recession?
What is stagflation, compared to recession? Sadly, and alarmingly, there are levels of Stagnation. At its worst, it’s an economic cycle that can lead to recession. Economic policy actions are taken to combat stagflation, such as raising the interest rates, as the federal reserve did in May and again in mid-June 2022.
Yet when the federal reserve raises interest rates in an effort to combat inflation, that can worsen unemployment rates – as employers fight to run their businesses while facing higher costs. When inflation jumps and the federal reserve approves interest rate hikes, a period of stagflation occurs. Stagflation at its worst is a Recession.
Stagnation Vs. Inflation
High inflation and unemployment rates affect each other. Higher inflation means consumer purchasing power lessens. They have less money to spend. When the money supply is tight for consumers – in other words, when their dollars don’t go as far – they pull back on spending.
That puts a crunch on businesses. During periods of inflation, leading to stagflation, no real economic growth can happen. Economic research has proven that businesses put growth plans on hold during such times. The businesses are also facing price pressures, as their costs for supplies, utilities and borrowing capital increase.
Stagflation Vs. Economic Stagnation
Economic stagnation is a period of no economic growth. It is a stage of stagflation, marked by higher prices for goods, including raw materials that businesses need, and services. Many economists would agree that as economic stagnation periods lengthen, the possibility of recession looms larger.
What Causes Stagflation?
Most economists define stagflation as being caused by these five factors:
Negative GDP Growth
GDP is the Gross Domestic Product, which is a measure of the country’s domestic output. Supply-side economists factor in the rate of inflation when calculating the true GDP.
For the past 2 years, the GDP has been in decline due to slow economic growth. Higher growth in the GDP indicates a healthy economy.
- Consumer Spending: As the largest component of GDP, when consumer spending falls, the entire GDP takes a significant hit. Consumer hesitation can be due to several reasons, such as future economic uncertainties or present financial difficulties.
- Business Investment: A decline in business investments, like capital expenditure or research and development, affects the GDP. Businesses may pull back on these investments when they foresee economic challenges.
- Government Spending: If governments cut back on their spending, perhaps to reduce national debt or in response to reduced tax revenues, GDP can be negatively impacted.
- Net Exports: A country’s GDP is also determined by its net exports. When exports fall or imports surge, it can lead to a negative contribution to the GDP.
- Natural Disasters: Events like hurricanes, floods, or wildfires can destroy infrastructure, property, and businesses, leading to a temporary decline in GDP.
High Unemployment
Unemployment rates have been decreasing since pandemic restrictions eased, but the economy hasn’t returned to pre-pandemic employment numbers.
At the same time, small businesses were largely unable to compete for workers compared to the higher wages that medium and large businesses could offer. The unemployment rate is low, but the US is still 2 million jobs less than pre-pandemic levels.
| Unemployment and Stagflation | Description |
|---|---|
| Technological Displacement | As technology advances, certain jobs can become redundant, leading to unemployment in those sectors. |
| Structural Changes | Shifts in the economy, like moving from a manufacturing-based to a service-based model, can leave many without jobs. |
| Mismatch of Skills | Sometimes, there are jobs available, but the unemployed don’t have the necessary skills to fill those positions. |
| Seasonal Unemployment | Certain sectors, like tourism or agriculture, may have job fluctuations depending on the season. |
| Labor Market Rigidity | Inflexibility in the labor market, whether due to stringent labor laws or powerful labor unions, can also contribute to high unemployment. |
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Supply Chain
The pandemic caused supply shocks all through the chain, from production to delivery. As the economy faced a lack of supplies, the higher demand for items threw price controls out the window. Supply chain issues contributed to the rise of inflation.
Interest Rates
The federal reserve raised interest rates in hopes of keeping inflation from reaching the double digits and settle the economy. Inflation is a contributing factor to stagnation, as consumers and businesses have less money to spend. Discretionary spending decreases as money is set aside for necessities, such as financial obligations and utilities. When the Fed raises interest rates, central banks soon respond by also raising rates.
Inflation
High prices are part of inflation. Inflation affects businesses, who pay more for supplies and utilities. Their customers are facing the same challenges and reduces spending.
Stagflation and Economic Growth in the US
It’s not as if Stagflation is something new. It can be part of the economic cycle in every government. The US had a period of stagflation in the 1970s. Then-President Richard Nixon initiated a monetary policy that put a 90-day freeze on wages and prices, and levied a 10% tax on imports. Stagflation still hit its lowest point with a national recession.
How Stagflation Affects Small Businesses
Consumers and small businesses feel the pinch of stagflation. Here are the main ways:
Rising Prices
Small businesses are paying more for supplies, utilities, and financial obligations. Those costs are passed on as higher consumer prices, as businesses are forced to raise prices. It’s a trade-off.
Spiking Oil Prices
The rise in the prices of oil and gasoline/diesel has reached historic levels. The rate of inflation for oil and gasoline/diesel has been staggering. The country is facing an oil crisis, with the winter months to come.
Although unemployment rates are decreasing, the nation is still about 2 million jobs short of pre-pandemic employment levels.
Rising Interest Rates
When the Federal Reserve raises interest rates, the central bank responds to raise interest rates. The cost of borrowing capital increases for small businesses. Many small business loans have variable rates of interest. The rising interest rates increase the amount of monthly payments.
Supply Chain Issues
These issues will continue, as manufacturers struggle to find raw materials, and also sustain the costs to deliver the materials.
Consumer Confidence
As prices rise, consumers drawback spending habits, especially on luxury items.
Preparing for Stagflation
- Refinance any loan with a variable interest rate
- Shop for a business credit card that has a no-interest introductory rate
- Focus on customer relationships
- Focus on vendor relationships
- Pivot the business
- Cut expenses, such as travel
How Does Stagflation End?
There are three conditions that are part of stagflation – flat job growth, no wage increases, and a stale stock market.
Economic policy changes can slow stagnation and possibly help the economy turn around. If the three conditions worsen, stagflation ends with a Depression.
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