What is stagflation, and does it lead to a recession? What you need to know as global economic worries grow

Most companies won’t know at first whether it’s just their products that are suffering or the entire economy. They slow or stop hiring because they don’t need as many workers now that sales are lower. Imagine living in an economic downturn where people are losing their jobs while bills and the cost of living keep on rising. Stagnant growth and high inflation are a killer combo that can do great damage to an economy and leave scars for decades to come.

Now, to begin, it’s important to note that stagflation isn’t really a very precise term with a strict definition. The term dates back to the 1960s in the United Kingdom, when it was used to describe a period that defied textbook economics because both unemployment and inflation were high at the same time. Why we’re hearing about the term today is more about where people are worried the economy may be headed.

  1. The price of oil in North America quadrupled, causing a sharp rise in inflation alongside an economic contraction, as business costs rose and consumer demand dropped.
  2. This is another question that simply doesn’t have a very good answer.
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The worry is they hike rates too high, too fast, triggering a recession. But we prefer to stick with the traditional application that requires rising and avatrade review higher unemployment. According to the supply-shock theory, the sudden decrease in the supply of a commodity or service will usually lead to stagflation.

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In the U.S., every dollar of economic output takes 70% less petroleum to produce than it did in the ’70s. Cost-push inflation occurred in 2005 after Hurricane Katrina destroyed gasoline supply lines in the region. The demand for gas did not change but the lack of supply raised the price of gasoline to $5 a gallon.

What Is Stagflation, What Causes It, and Why Is It Bad?

Gold performed well in the 1970s, as it and other precious metals are seen as a traditional hedge. Commodities also performed well, particularly oil (of course, there was an embargo) and other commodities of limited supply. Real estate also served as a good hedge, as it was less correlated to stocks. However, aside from a brief but severe recession due to the pandemic lockdowns in 2020, the economy muddled through, with gross domestic product (GDP) mostly positive and relatively steady. Stagflation is uncommon, but it has happened a couple times in the last several decades.

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These types of economic crises are difficult to defeat because the traditional play of lowering borrowing rates to stimulate growth is taken off the table. Urbanist and author Jane Jacobs saw the disagreements between economists on the causes of the stagflation of the ‘70s as a misplacement of scholarly focus on the nation rather than the city as the primary economic engine. She believed that to avoid the phenomenon of stagflation, a country needed to provide an incentive to develop “import-replacing cities”—that is, cities that balance import with production. This idea, essentially the diversification of the economies of cities, was critiqued for its lack of scholarship by some, but held weight with others. December’s headline inflation was faster than November’s rate of 3.1 per cent, Statistics Canada said Jan. 16, but the increase was mainly attributed to base effects from a plunge in gas prices in 2022. To curb these economic challenges, President Richard Nixon enforced regulations to freeze prices and wages.

Jane Jacobs and the influence of cities on stagflation

The chart shows the pattern, based on a sudden, one-time change in monetary policy. The chart shows how much of the total effect occurs at a particular point in time. Six months into the monetary tightening, we have about half of the total hit to employment, with the other half still to come. But inflation is actually worse, as interest rates increases pushed up business costs. After a year of the monetary tightening, the effect on inflation is finally starting, but employment is nearing its full impact. A year and a half out, the employment pain is easing but we sill have not reaped the full benefit of lower inflation.

A recession is another economic phenomenon which is considered to be normal. 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. What’s indisputable is that it took a pair of painful recessions to bring down inflation for good and legislation enacting larger U.S. budget deficits and economic deregulation to revive growth during Ronald Reagan’s presidency.

The overarching theory is that a broad supply shock occurs in the economy, which causes a rapid increase in prices. Can you think of a recent event that may have caused a supply shock capable of derailing the global economy? The COVID-19 pandemic caused a sudden reduction in production in a variety of industries from medical equipment to semiconductors. The reduction of those industries reduced the production of all sorts of things from cars to appliances. Suddenly, hospitals everywhere, as well as humans in general, needed personal protective equipment, placing a huge strain on the supply of the raw ingredients that go into producing them.

The hallmark of stagflation is an economy that is experiencing slow growth and a high unemployment rate and consumers with less money to spend. Many early economic theorists like John Maynard Keynes completely discounted the possibility that these two things could exist at the same time, thus removing unemployment and inflation from their economic models. This was because unemployment and inflation were thought to have an inverse relationship. If a central bank wanted to lower unemployment, it generally caused inflation, and if they wanted to lower inflation, it generally caused more unemployment. In the late 20th century, stagflation started to take hold and has happened several times over the course of the last four decades. The term is a combination of economic stagnation – which is an indicator of a faltering economy – and economic inflation, where the value of an individual dollar is reduced.

Hedging Against Inflation

In 1971, Nixon closed the gold window that allowed for the exchange of dollars for gold. In 1976, the value of the U.S. dollar was officially decoupled from gold. Both moves devalued https://forex-review.net/ the dollar which impacted inflation and economic growth and led to stagflation. After a few months, the first effects of monetary tightening are felt in weaker sales by businesses.

In between, employment is slowing but inflation is not yet coming down. At this point, a lot depends on the effectiveness of interest rate rises curtailing demand and whether major supply shocks can be ironed out quickly. If inflation doesn’t ease soon, then the U.S. and global economies could face more than just a regular recession.

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There are other signs inflation could be “stickier” than Canada’s central bank would like. Registration granted by SEBI, membership of BASL (in case of IAs) and certification from NISM in no way guarantee performance of the intermediary or provide any assurance of returns to investors. The examples and/or scurities quoted (if any) are for illustration only and are not recommendatory.

They can’t do that now, though—inflation is high, and that’s potentially very worrying. Stagflation is a portmanteau, that is, a word that blends two others (in this case, “stagnation” and “inflation”). In general, the stage is set for stagflation when a supply shock occurs. This is an unexpected event, such as a disruption in the oil supply or a shortage of essential parts.

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