Are We Nearing a Period of Stagflation?

What Is Stagflation?

Stagflation is a perplexing economic phenomenon where an economy experiences a combination of stagnant growth, high unemployment, and rising inflation simultaneously. This unique and challenging situation defies the conventional wisdom that inflation and unemployment are inversely related, making it a conundrum for policymakers. Stagflation typically occurs when an economy faces both supply and demand-side shocks. Supply-side shocks, such as disruptions in the oil supply, can drive up production costs, leading to higher prices for goods and services. Meanwhile, demand-side factors, like weak consumer spending and decreased investment, can lead to slowed economic growth and rising unemployment. Stagflation presents a formidable challenge for central banks and governments, as the usual policy tools to combat inflation or unemployment often exacerbate the other problem. Understanding and managing stagflation remains a complex puzzle for economists and policymakers alike.

What We Can Learn From The 70s

Let’s journey back to the last period of stagflation, a daunting economic challenge that lasted throughout the 1970s. This turbulent decade was marred by the convergence of two adverse oil shocks and an ill-fated policy response that resulted in a disheartening mix of inflation and recession. The first shock was ignited by the oil embargo imposed against the U.S. and the Western world in the aftermath of the 1973 October War in the Middle East. The second shock followed in 1979, triggered by the Islamic revolution in Iran. In both instances, the spike in oil prices sent shockwaves through the global economy, stoking inflation and causing economic contractions in oil-importing Western nations. What compounded the problem was the policy response—or rather, the lack thereof—by central banks. They failed to promptly tighten monetary and fiscal policies to rein in the mounting inflation, leading to a distressing scenario of double-digit inflation and a severe economic downturn.

However, this period of stagflation was followed by a stark departure in the economic landscape, known as the “Great Moderation.” This era, characterized by relative economic stability, low inflation, and steady growth, marked an exit from the turbulent 1970s. Central banks adopted more credible inflation-targeting policies, and governments adhered to conservative fiscal practices. But even more significant than demand-side policies were the myriad positive supply shocks that bolstered this period. Factors like increased potential growth, reduced production costs, and the integration of emerging economies like China, Russia, and India into the global market played a pivotal role in maintaining low inflation.

During the era of hyper-globalization that followed the Cold War, an efficient allocation of production to cost-effective locations, driven by technological innovations and geopolitical stability, further contributed to this economic equilibrium. The massive movement of labor from the Global South to the North, coupled with the supply of low-cost goods, services, energy, and commodities, kept wages in advanced economies in check, further restraining inflation.

Present Day – Factors to Consider

In the current economic landscape, we find ourselves facing a new set of challenges and uncertainties that set this period apart from history. On top of already high inflation, various geopolitical and demographic issues as well as an upcoming election add a layer of complexity to the situation.

This dynamic landscape prompts us to consider the possibility that the decade ahead may be defined by a prolonged period of inflation, requiring a delicate balancing act to sustain low unemployment and ongoing economic growth.

However, as we navigate this uncharted territory, there are several reasons to be optimistic that the next cycle won’t be a repeat of the 1970s:

1. Smaller commodity price jumps: Materials and resources have risen at a more manageable pace, thanks to improved supply chain management and technological advancements over the past few decades.
2. Smarter monetary and fiscal policies: Improved policy frameworks and more accurate inflation expectations have led to a greater focus on price stability.
3. Quicker supply and demand responses: Supply chains and markets have become more efficient and responsive to changing conditions or disruptions in sectors where prices are rising rapidly.
4. Low unemployment: Today, unemployment is less than 4% – the lowest it’s been in 54 years.

Bottom Line

In today’s complex environment, where inflation remains of utmost concern, it becomes increasingly vital for us to understand the dynamics at play and consider how each of these scenarios could impact investment performance if they were to occur.

Remember, during any volatile period, it’s essential to resist the urge to panic. Instead, maintain an active stance in the market, have confidence in where you’re investing, and continue to diversify your portfolio with real assets that can withstand the effects of inflation.

Let knowledge be your guide through the market’s ebbs and flows in the upcoming cycle!

Sources:

https://www.brookings.edu/articles/todays-global-economy-is-eerily-similar-to-the-1970s-but-governments-can-still-escape-a-stagflation-episode/

https://www.commerce.gov/news/blog/2023/02/news-unemployment-its-lowest-level-54-years