The oil price shocks of the 1970s provided what would become a textbook example of how stagflation can emerge. After OPEC imposed an oil embargo in 1973, energy costs surged, increasing production and transportation expenses across the economy. Companies faced with higher costs had to either reduce output (leading to layoffs) or raise prices (feeding inflation), and many did both.
Whilst Endowus HK Limited (“Endowus”) has tried to provide accurate and timely information, there may be inadvertent delays, omissions, technical or factual inaccuracies or typographical errors. Another key asset class designed to protect against inflation is inflation-linked bonds. The complex interplay of these factors makes asset allocation difficult, underscoring the need for careful planning and diversification in portfolios to mitigate the adverse effects of stagflation. Focus on high-interest debts first, such as credit cards, and then move on to lower-interest debts, such as auto loans. Lowering your monthly minimum required payments can help you manage a tough economic period.
Current Risk of Stagflation
Inflation and unemployment are supposed to have an inverse relationship, making it easier for central banks to manage things by adjusting interest rates. But if this is how the economy is supposed to work, stagflation is a puzzling paradox. And it forces central bankers and policymakers to devise new ways to solve the problem. Stagflation is a profoundly difficult problem for policymakers to combat. Unlike typical recessions or periods of high inflation, stagflation defies conventional economic solutions because addressing one aspect typically worsens the others. Worryingly, the potential stagflation of the mid-2020s would occur in an economy with much higher debt levels and lower interest rates than in the 1970s, limiting the policy options available to governments and central banks.
Businesses can also benefit from extra savings to keep running smoothly during economic struggles. The first public use of the term “stagflation” occurred in the British Parliament in the mid-1960s in reference to high inflation and unemployment at the time. Unfavorable demographic trends caused by an aging population that leaves fewer people in the workforce alongside increased taxes and regulations could cause economic growth to stagnate, Rosen says. Stagnant economic growth is a bit harder to comprehend as it can be less immediately apparent.
The 1970s Stagflation Crisis
In the 1970s, critics argued that the U.S. government and the Federal Reserve made poor policy decisions that increased inflation without boosting economic growth. In the 1970s, Stagflation became a big problem because of an increase in oil prices. The first was in 1973 when oil-producing countries (OPEC) stopped selling oil to some nations, and the second happened due to the Iranian Revolution in 1979. And Mark Hackett, chief market strategist at Nationwide Investment Management Group, says that stagflation is a major market risk. “If growth slows and inflation reaccelerates, the Fed could find itself stuck in a box without a clear exit strategy,” he adds.
During stagflation, consumers face the double burden of high prices and weak economic growth, eroding their purchasing power. Recessions, however, may lead to lower prices due to decreased demand. As production costs rise, companies may be forced to raise prices to maintain profits. But with consumers spending less due to high prices and weak economic growth, demand for products drops.
Inflation vs Stagflation
Previously, she was a fully licensed financial professional at Fidelity Investments where she helped clients make more informed financial decisions every day. She has ghostwritten financial guidebooks for industry professionals and even a personal memoir. She is passionate about improving financial literacy and believes a little education can go a long way. You can connect with her on Twitter, Instagram or her website, CoryanneHicks.com. Economist Larry Summers, a former Treasury Secretary, argued in a March 2022 op-ed in The Washington Post that the Federal Reserve’s current policy trajectory would likely lead to stagflation and ultimately a major recession. According to the National Bureau of Economic Research, the economy fluctuates between growing and contracting as part of the typical economic cycle—and, in fact, there have been seven recessions in the U.S. in the past 50 years.
“That this index is widely referred to as the ‘misery index’ shows how painful stagflation is,” Brochinm says. “Investors might be tempted to make drastic changes to their portfolios if they are concerned about stagflation, but we continue to believe that diversification and taking a long-term investing approach are key,” Martin says. “We suggest folks stay invested in the market – focusing on investments that are in line with their risk tolerance and objectives.” He adds that investors should also stay focused on high-quality picks. All of this is to say that stagflation can be worse than a recession. “Stagflation is more difficult to manage than a recession, and can have a longer, more negative impact on individuals, businesses and overall economic stability,” Brochin says.
How Could the Trump Tariffs Set Off Stagflation?
- Inflation and unemployment are supposed to have an inverse relationship, making it easier for central banks to manage things by adjusting interest rates.
- In the 1970s, expectations about future changes in prices and about future economic activity became very important.
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- Central banks respond as they normally do to economic turmoil by making sure money is cheap to borrow so they essentially feed the flames of inflation, stimulating demand and pushing prices up further.
- Today, some economists are worried that the world might face stagflation again.
Those concerns are driven by worry about both the inflationary impact of tariffs and potential for them to dampen economic activity, among other concerns. Investing in a single asset carries concentration risk, while frequently adjusting holdings can increase market timing risk. Endowus advocates for a disciplined, long-term strategy based on sound investment principles. In periods of stagflation, diversification becomes even more crucial.
Slowing GDP Growth
These events caused inflation to spiral out of control and threw the economy into disarray, along with easy monetary policy that the American central bank, the Federal Reserve, pursued to lift employment. Very high interest rates and a difficult recession were necessary to restore order. Stagflation denotes a situation characterized by stagnant economic growth, high inflation, and unemployment. In contrast, deflation specifically signifies a continual decline in the overall price level of goods and services within an economy. If a government spends excessively or prints too much money without corresponding economic growth, it can lead to severe inflation. However, if the economy is already weak, such policies often fail to create new jobs, resulting in both high inflation and rising unemployment.
Investing
Knowing What is Stagflation and how it different from inflation can help people and businesses to make better plans. “At the same time, inflation reduces the purchasing power of households and consumer confidence declines, further impacting economic growth,” he says. “In such economic conditions, businesses and individuals face difficulties in planning and making investment decisions.” “During a period of stagflation, businesses struggle to grow due to slowing economic activity, and cannot easily reduce costs due to rising input prices,” Brochin says. This leads to layoffs and fewer job opportunities, causing unemployment to rise.
“If you’re best mt4 indicators, best free indicator forex download an investor, you need to play off expectations as much as reality,” he says. But stagflation never arrived, and McMillan isn’t worried about another episode happening any time soon. He says that’s because the economy is fundamentally different today than it was back then. While it’s unlikely that the U.S. economy is headed for another bout of stagflation, it’s important to contextualize what’s happening with the prominent episode of stagflation in the 1970s. It’s always the right time to pay off high-interest debt, but there’s nothing like the high probability of stagflation to put the pressure on.
Money Moves You Need To Make Before Interest Rates Change Again
For instance, when governments print too much money to stimulate the economy, it can lead to inflation without boosting growth. Similarly, if governments don’t address underlying economic problems, they might inadvertently create the conditions for stagflation. Property, a tangible asset, acts as a robust shield against stock market fluctuations in stagflation.
- For example, raising interest rates to combat inflation can slow economic growth and increase unemployment, while lowering rates or increasing government spending to boost growth can fuel inflation.
- To fight inflation, they may raise interest rates, but doing so could further slow economic growth and increase unemployment.
- Stagflation is an economic phenomenon characterised by the simultaneous occurrence of high inflation, stagnating economic growth, and elevated unemployment rates.
- When oil prices rise, businesses face higher operating costs, which often leads to increased prices for goods and services.
- Conversely, prioritizing growth through fiscal measures can amplify inflationary pressures.
Founded in 1993, The Motley Fool is a financial services company dedicated to making the world smarter, happier, and richer. But one measure seems to support the idea that stagflation should not be a top-of-mind concern for investors at the moment. In the 1970s, economist Arthur Okun developed an index to measure stagflation that is calculated by adding the unemployment rate to the annual inflation rate.
For example, an easy monetary policy where interest rates are being lowered combined with a tight fiscal policy can lead to wage retaliation if taxes remain too high. As workers demand higher wages, businesses may reduce employment and pass the higher costs onto consumers by raising prices. Those supply shocks followed a period of accommodative monetary policy in which the Federal Reserve grew the money supply to encourage economic growth. Meanwhile, global economic growth slowed sharply in the 1970s—a decade marked by two different recessions in the U.S. and the lead-up to a third one that began in 1980. Higher tariffs can have the same effect, especially when put in place very quickly. When companies face higher input costs, they typically pass that on to consumers through higher prices (how much depends on the sector and is a matter of debate) while also reducing production, leading to layoffs.