Of course, as a Financial Advisor, you know what stagflation is, but some clients may be unfamiliar with it. For those who are newer to the world of finance, trying to understand all the jargon and technicalities in finance-related topics can be an overwhelming task. Chances are that you or your clients don’t have the time to scour through various articles and textbooks, so we did that for you.
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The Finance Essentials Series examines the most pressing stock market and financial news and breaks down what may be difficult for your clients to understand. Today we analyze the phenomena of stagflation and its previous occurrences. We hope this article can be informative for your clients.
In recent weeks, you may have seen the word “stagflation” all over the news headlines – and for good reason. The invasion of Ukraine and frequent coronavirus lockdowns in China have put significant strain on the global supply chain, while consumer prices hit a 40-year high. Economists and the World Bank alike have warned that the global economy could be headed towards a period of “stagflation”, with slow economic growth, high inflation, and high unemployment.
What is stagflation and why is this important?
Stagflation, which is a combination of the words stagnation and inflation, is a phenomenon in which economic growth declines while prices increase. Oftentimes, slow economic growth coincides with high unemployment rates and stagnant wages. Skyrocketing prices and sluggish job growth have the potential to be disastrous for the economy, even if unemployment rates stay relatively flat.
“The pain of stagflation could persist for several years, with potentially destabilizing consequences for low- and middle-income economies,” says World Bank chief David Malpass.
In the U.S., high prices for consumer goods, coupled with weak economic growth and increased unemployment, would lead to tight household budgets, reduced consumer spending, and limited business growth (if any). Increasingly expensive products, limited supply, and job loss would be a frightening scenario for people worldwide.
In normal circumstances, the Federal Reserve could raise interest rates to fight inflation, but in the case of stagflation, this may further debilitate an already weakened economy. While stagflation couldlead to a recession, “a recession is a risk scenario, not a baseline”, according to Allianz’s chief economic advisor, Mohamed El-Erian.
What causes stagflation?
In the mid-1970s, America entered a period of stagflation. Many experts blame the 1973 oil embargo, the War in Vietnam, and the decline of the manufacturing sector. However, that alone was not enough to cause stagflation; “conflicting contractionary and expansionary fiscal policies” also had a significant role.
Roughly 50 years later, in 2022, the threat of stagflation is looming. The war in Ukraine, together with the coronavirus pandemic, has significantly disrupted global supply chains. Food and energy prices have shot up, while the market has declined.5
The exact cause of stagflation is a culmination of several different factors. But by looking at history, we can observe that geopolitical chaos, a sudden suspension in supply chains, and policy errors seem to act as a catalyst for stagflation.5
Ultimately, the power to prevent stagflation is in the hands of the central banks, and they’re currently backed into a corner. While the Federal Reserve continues to raise interest rates, there is the potential risk of putting the economy into a recession. But if they had not raised interest rates, consumer prices could have spiraled further out of control.
We are living through extraordinary times, and in turn, extraordinary economic conditions. We developed this series with the objective of simplifying financial topics to offer you a valuable resource to provide to your client’s during these economic circumstances.
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