What is Stagflation and How does it Impact the Market?

Most central banks are terrified of the term “stagflation.” This phrase describes a toxic mix of declining GDP and growing unemployment that results in economic stagnation. When stagflation occurs, prices stay high, but consumer spending declines, making purchasing the same commodities more expensive and stagnant demand in the country’s economy. In the middle of the late 1970s, the United States suffered stagflation as high oil prices from OPEC oil embargoes pushed inflation higher even as recessionary conditions reduced GDP and raised unemployment. As it dramatically impacts business, investors, individuals, and government, it is crucial to understand stagflation clearly. 

What is Stagflation?

The term was coined by Macleod in 1965 to describe sluggish economic growth and high inflation. He linked this condition to low productivity, excessive government expenditure, notably on subsidies to keep essential prices low, and a persistent trade imbalance. When imports surpass exports, there is a trade imbalance, meaning that the economy generates less than it consumes.

What are the impacts of Stagflation?

  1. Causes Great stress

Stagflation is a very unpleasant economic situation. Economists even developed the misery index to gauge how financially distressed the ordinary individual is under this phase. This rate is computed by multiplying the inflation rate by the seasonally adjusted employment rate. Ronald Reagan’s first term had the most significant level of unhappiness ever recorded.

  1. Impacts businesses

Enterprises, especially small businesses, are squeezed by stagflation. In most cases, when input costs rise, businesses may raise prices while still being competitive since they know that other businesses are also dealing with the same problem. Stagflation, on the other hand, results in a significant number of unemployed individuals and stagnant earnings, making it impossible for consumers to afford increased costs. 

During stagflation, firms frequently see labor disruptions as workers demand higher pay in response to rising prices. However, when sales are low, firms cannot afford to boost salaries. Consumers are unable to spend, which causes firms to see a decline in clientele.

  1. Higher unemployment

As businesses are significantly impacted, they resort to cost-cutting and even layoffs. Stagflation can result in massive layoffs and higher unemployment levels in the country. Furthermore, people who lost their jobs find it very hard to get another job, impacting their personal and professional lives. 

Because goods and services are more expensive when there is inflation in the economy, fewer individuals can afford to buy things. The country’s cost of living increases as the currency’s value falls. Economic growth slows down when inflation is strong because rising living expenses also raise prices.

Nevertheless, a healthy inflation rate (2–3%) is seen favorably since it keeps capital moving in an expanding economy and immediately leads to rising salaries and business profitability.

Stagflation causes a great deal of harm. It depletes people’s earnings and savings, compels companies to reduce employment and investment, and harms the government’s revenue base. And if it persists, it may be difficult to treat without suffering significant financial hardship. But to tackle this situation smartly, each player needs to understand stagflation properly and take necessary steps accordingly. Smart business owners are modifying their tactics for a future slowdown or recession to make their companies recession-proof.

Muhammad Saad Khan

Experienced Finance Officer with a demonstrated history of working in the marketing and advertising industry. Skilled in Microsoft Word, Income Tax, PowerPivot, Management Reporter, and Microsoft Dynamics GP. Strong finance professional with a ICMA (Part Qualified) focused in Accounting and Finance from Institute of Cost and Management Accountants - ICMA. I write finance related article in my free time on TrendMut.

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