Stagflation explained: Why is it bad and what’s the cure for it 

Consumers, investors and economists are worried that three economic enemies - inflation, slowing demand and unemployment - may combine and form a major crisis called ‘stagflation’ for the entire globe.  

Experts are also saying that some may already be feeling the pinch of stagflation. However, this concept of stagflation is complicated as not all inflation leads to it. Here’s all you need to know about stagflation, including how it works and how you can prepare for it. 

What is stagflation?

Typically, stagflation happens when a country’s economic growth slows, demand falters, and unemployment rises despite climbing inflation.  

Because unemployment doesn’t usually support growth, and when demand nosedives, so can inflation. However, this is out of the ordinary as businesses would likely drop investments because the consumers are spending less and/or have limited amounts of money for purchases. 

Concepts like this are at the heart of the theory called the ‘Phillips curve,’ which shows that as unemployment falls, inflation should rise, and vice versa. But these theories would fall on its face in stagflationary conditions.  

For example; In the US, both unemployment and inflation were on the rise at the same time throughout the 1970s and 1980s, which according to the experts was stagflation. In May 1975, joblessness reached 9 per cent, while around six months earlier, rising prices were at 12.2 per cent in November 1974.  

Both remained elevated till the early 1980s when the US Federal Reserve thoughtfully manufactured a recession and raised interest rates to intervene. 

What causes stagflation?

Stagflation is usually caused due to supply disruptions, and given the current situation in the light of the Covid-19 pandemic and the Russia-Ukraine war, this is a basic result. In other words, stagflation generally occurs when the money supply is expanding but supply is being constrained. 

For example; If a fast-spreading bird flu strain affects a substantial population of the chicken, a shortage could raise the prices of eggs and meat along with reduced production and curbs on employment. This is mostly similar to today’s semiconductor chip shortages which have pushed car prices up because of supply constraints. 

Oil Prices: Some experts say that stagflation is caused when a sudden increase in the cost of oil reduces an economy's productive capacity due to rising transportation costs and production costs. This will make the prices increase even as people were laid off.  

Poor Economic Policies: Some experts also believe that inflation and the confluence of stagnation are the results of poorly made economic policy. Harsh market regulation, labour, and goods in an inflationary environment are cited as the possible cause of stagflation. 

Why is Stagflation Bad? 

Stagflation is a conflict in which slow economic growth leads to an increase in unemployment but without rising prices. This is why this Stagflation is considered bad as increasing the unemployment level would result in a drop in consumer spending power. 

How to prepare for possible stagflation:

1. Take advantage of the current strong job market:  

Even if the economic growth slows, businesses would still have a demand for workers. Take advantage of that by negotiating a raise or looking for a new position. Data suggests that job switchers see bigger pay gains. 

2. Create and follow a budget: 

High inflation could make it crucial to evaluate where your money is going each month. Managing your finances, track spending and then compare that with where prices are rising the most. Strictly sticking to a budget could help you avoid purchasing items that are inflated and free up crucial amounts of cash. 

3. Plan for emergencies ahead 

Use some freed-up cash to start a new emergency fund or keep adding it to an existing one. Experts recommend that building up at least six months of your expenses in cash can act as a cushion for a period of joblessness. 
 
4. Think about your bear-market strategy 

No investor likes to take losses, especially if that money is going toward, one’s retirement or a long-term goal. However, in times of severe market volatility, avoiding overreactions is important. Avoid selling off and diversify your investments. 

Also read: Calling current econ situation as stagflation a misnomer: Madan Sabnavis