Experts say that such periods of sustained, high inflation are most likely caused by either a global supply shock or poorly-guided economic policies. The consensus among economists is that productivity has to be increased to the point where it will lead to higher growth without additional inflation. This would then allow for the tightening of monetary policy to rein in the inflation component of stagflation.

A system of compelling the exchange of commodities at what is not their real relative value not only relaxes production, but leads finally to the waste and inefficiency of barter. There’s no question that we’re currently experiencing record-high inflation. Stagflation marked the worst performance by advanced economies between the Great Depression and the Great Recession, and as such left a lasting mark.

A wage-price spiral seemed improbable for decades after Paul Volcker’s Fed tamed inflation in the early 1980s, bringing stagflation to an end. In the aftermath of the 2007 to 2008 Great Recession and financial crisis and until 2021, inflation mostly fell short https://g-markets.net/ of the Fed’s targets amid lackluster economic growth. The causes of stagflation during that period remain in dispute, as did the likelihood of a reprise in 2022 amid high energy and food prices, rising interest rates, and persistent supply-chain snags.

1. As a result, prices rise in response to expansionary monetary policy without any corresponding decrease in unemployment, while unemployment rates rise or fall based on real economic shocks to the economy.
2. In the decades since, there hasn’t been a time when those three factors—high inflation, slow economic growth, and a rapid rise in unemployment—occurred simultaneously and for a prolonged period.
3. And if price increases stay high for long enough, consumers could begin to expect constantly rising prices as the new normal and will change their behavior accordingly, creating a self-fulfilling inflation cycle.
4. A lot depends on individual circumstances, what rate you’re offered, and how long peak inflation persists—which is anyone’s guess right now.

As we normally understand the economic cycle, economic growth comes with an increase in jobs and, eventually, a rise in the price of goods and services, aka inflation. (The Fed’s target for “healthy” inflation is around 2%.) In contrast, when the economy slows, the job market begins to contract, and inflation also cools. It seems like a simple solution—lowering/raising interest rates to stimulate or slow down the economy, as if all the central bank has to do is flip a switch. Nominal factors like changes in the money supply only affect nominal variables like inflation. The neoclassical idea that nominal factors cannot have real effects is often called monetary neutrality[32] or also the classical dichotomy. Those supply shocks followed a period of accommodative monetary policy in which the Federal Reserve grew the money supply to encourage economic growth.

How to Navigate Stagflation

While the U.S. has sidestepped another bout of stagflation since the 1970s, some commentators have drawn parallels between that episode and recent dynamics in the economy. Not many traditional asset classes fare well in that kind of environment. The best performers probably will be those with inflation-hedging characteristics, such as inflation-indexed bonds, gold, and possibly real estate. Inflation is unusually high, and the economy is, well, not exactly firing on all cylinders.

Understanding Stagflation

Kotlikoff paints a financially savvy scenario of taking out a long-term mortgage while simultaneously purchasing and holding long-term, inflation-indexed Treasury bonds. “You’ll win on your mortgage repayment if inflation continues or rises and be hammer formation protected on your Treasury bond investment with one big caveat — the inflation protection is taxed,” Kotlikoff explains. We can infer that as long as the economy’s expansion stalls and inflation remains high, there will be a fear of stagflation.

Why is stagflation a problem?

The CPI measures the weighted average of prices of a basket of consumer goods and services. When tracked over time, the CPI provides insights into consumer prices’ direction. The CPI is often referred to as “headline inflation.” The Federal Reserve works to get the inflation rate to an average of 2% over the long term using its Personal Consumption Expenditures index. When the CPI and PCE begin to rise beyond 2%, investors start to worry about inflation. After Iain Macleod, a British Conservative Party politician, used the term stagflation during a speech to Parliament in 1965.

If prices continue to rise, it could make sense to buy now rather than wait. However, lackluster economic growth might also weigh on house prices, while the high interest rates needed to combat inflation will mean less favorable borrowing terms. A lot depends on individual circumstances, what rate you’re offered, and how long peak inflation persists—which is anyone’s guess right now.

Time in the market

In economics, stagflation or recession-inflation is a situation in which the inflation rate is high or increasing, the economic growth rate slows, and unemployment remains steadily high. It presents a dilemma for economic policy, since actions intended to lower inflation may exacerbate unemployment. Inflation is a singular phenomenon that can have multiple causes and many inflationary episodes don’t fit neatly into one of the categories above. The inflation of the 1970s has been variously attributed to the cost-push of oil price shocks and the demand-pull of relaxed fiscal and monetary policies. This is accompanied by an increase in the inflation rate (rising prices). Stagflation isn’t as common as other economic circumstances, but it does happen occasionally.

Productivity measures may be examined collectively across the whole economy, or they may be viewed individually by industry to investigate trends in labor growth, wage levels, and technological improvement. A sound, long-term financial plan is the best way to protect your finances from stagflation. If you have been living within your means, stagflation should have no major impact on the way you live your life.

Germany’s Bundesbank stopped inflation becoming entrenched by stepping on the brakes early and committing itself firmly to stable prices. America’s Federal Reserve, in contrast, took too long to fight inflation, and had to break the new inflationary psychology later, under the leadership of Paul Volcker, through a painful recession. So far, economic data show that inflation may have peaked, while consumer spending remains strong. Online prices fell in May for the second month, Adobe Analytics reported this week. And wage increases, one factor behind rising prices, are also slowing.

Stagflation is very costly and difficult to eradicate once it starts. The combination of slow growth and inflation is unusual because inflation typically rises and falls with the pace of growth. The high inflation leaves less scope for policymakers to address growth shortfalls with lower interest rates and higher public spending. One obstacle in the way of a stagflationary re-rerun is the modern global economy’s significantly reduced dependence on energy to generate growth. Others include the historically large U.S. budget deficit, interest-rate increases by the Federal Reserve, and modest inflation expectations shaped by decades of low inflation.

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. Stagflation is a word that is a portmanteau of “stagnant” and “inflation.” It describes a period of low to nonexistent economic growth coupled with rapidly rising prices. It wasn’t until the early 1980s that the Federal Reserve—under new chairman Paul Volcker—cut the money supply and hiked interest rates to try to make it more expensive for businesses and individuals to borrow money.