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Is Stagflation Worse than Inflation?

Is stagflation worse than inflation_

The term “stagflation” has been surfacing across many media outlets recently. Many economists see similarities between today’s world economy and the stagflationary period of the 1970s, although some agree that the current macroeconomic environment today cannot be compared with what happened during the 1970s.

Saying the word “stagflation” may just be another tactic from the news and media outlets to generate more exciting headlines, however, stagflation is a real term coined by the economist Iain MacLeod in 1965. This term refers to a period of time when the economy is experiencing recession and high inflation simultaneously.  So, theoretically, stagflation is worse than inflation. Why exactly is that? In order to answer this, we will look at the definition of  inflation and stagflation, and how it can be considered worse than just inflation.

What is inflation?

Inflation is a relatively simple term to understand: it is used to define an overall rise in prices, meaning a decline in purchasing power. Purchasing power is simple: it measures how much goods or services we can obtain based on a certain unit of currency. For example, in the year 1900 you could buy 10 boxes of cereal for only $1! Nowadays, what can a single dollar buy? a can of soda?

Many Western economies like the United States believe that a small amount of inflation is good, as inflation encourages consumer spending and limits the risk of deflation. With a small amount of inflation, people are encouraged to buy now, as the item may become more expensive the longer they wait.

The opposite is true for deflation: as consumers expect prices to drop during a deflationary period, they may hold out on a purchase and wait until the item becomes cheaper before buying. This encourages people to spend less, as they wait for better deals. The United States Federal Reserve believes that a benchmark inflation of 2% per year is considered healthy.

What is stagflation?

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Stagflation combines the words “stagnation” and “inflation”. So, stagflation is when an economy is experiencing a recession, yet there is inflation still going on with prices rising. Stagflation is a generally accepted term to describe an economy that is experiencing the following:

  • High inflation
  • High unemployment
  • Slow economic growth

This creates an economic situation that is unfavorable for an economy to prosper. High unemployment lowers the opportunities that people have to find work and sustain themselves. Business owners may not be able to generate as much profit, due to slow economic growth. On top of that, the rising prices caused by inflation mean that people have less purchasing power to buy goods and services, further reducing the amount that they can contribute to the economy. Therefore, stagflation creates unfavorable conditions for an economy to thrive.

Is stagflation worse than inflation?

As we mentioned earlier, high inflation is only one ingredient of stagflation, so it theoretically makes it worse than inflation alone. Also, some inflation is not necessarily bad. Many Western economists see how a small level of inflation can encourage consumer spending while limiting the risks of deflation, something that many economists deem worse than inflation.

The high inflation that we have experienced recently, however, may not be great for the economy, as many workers receive salary increases that are less than the current rate of inflation. This translates to people having less purchasing power. High inflation can lead to disastrous events for an economy, such as hyperinflation.  The fact that the economy is not growing and that unemployment is rising means that people lose purchasing power in exchange for no growth in the economy. 

High inflation is only one ingredient of stagflation, so it theoretically makes it worse than inflation alone. Also, some inflation is not necessarily bad.

The most well-known time in recent history of a stagflationary event was during the 1973 oil embargo, where OPEC countries no longer wanted to trade with the US. This skyrocketed oil prices, quadrupling costs over just a few months. This high inflation was during a time where there was high unemployment, and negative GDP growth.

Between 1973 and 1974, the S&P 500 index plummeted from a high of roughly 820 to a low of almost 372. That is more than a 50% drop. Of course, we can learn from past experiences but the future may not necessarily be similar to the past, even though there are similar underlying conditions. Although the United States is experiencing high inflation and a decline in GDP growth over the past two quarters, the unemployment rate is currently around 3.6% – much lower than during the 1970s.

So, should we be worried about entering a stagflationary period? Some people could make an argument that yes, stagflation in the near future is possible. However, are we currently in a stagflationary period? Many economists say no, and explain that there are many ways for us to avoid a stagflationary period.

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