Stagflation Explained

Amanda Luzzader

If you want to scare an economist, bring up the possibility of stagflation

As explained in a previous article, “inflation” is the term used to characterize a general and widespread increase in certain consumer goods and services over time. These include food, clothing, housing, transportation, energy, and even things like entertainment. More accurately, inflation is a measurement of the rate at which the prices of those goods and services are increasing (expressed by the percentage of increase annually).

Inflation is also a measure of the rate at which consumer purchasing power is decreasing. If virtually everything you must buy and would like to buy costs a lot more this year than it did last year, we may say that your money is simply worth less this year. Inflation as a measurement, therefore, is an attempt to quantify that decrease in monetary value with some degree of accuracy. As an example, an inflation rate of 7 percent means that your expenses and purchases across the board will cost you around 7 percent more than they did the previous year.

Inflation occurs naturally in any large economy, but it usually stays quite low, hopefully around only 1 or 2 percent. That’s where government policymakers would like it to remain. One reason inflation has been in the news a lot lately is because high rates of inflation have returned to the United States economy after an absence of about 40 years. The aforementioned 7 percent inflation is the amount of inflation measured in 2021, and it looks like 2022 will see a similar rate. Many factors have contributed to this current wave of inflation, including the COVID-19, worldwide supply chain troubles, and shortages of certain kinds of labor.

Along with stories about increasing inflation, you may have noticed another, related term (this one seemingly more alarming) that has also been slipping into headlines and news reports lately: “stagflation.”

What is Stagflation?

With increased prices and decreased buying power, the possibility of inflation is frightening to consumers. Nobody wants to spend more money while receiving less. However, if you want to scare an economist, bring up the possibility of stagflation

Stagflation (“inflation” plus “stagnation”) occurs when an economy has a high rate of inflation, a high rate of unemployment, and a slow rate of economic growth (i.e., “stagnation”). When these three conditions combine, consumers and businesses are stuck with high prices, fewer opportunities to grow and expand economically, and high unemployment. This situation leaves everyone more economically challenged than under inflationary conditions alone.

The specter of stagflation makes economists quake in their boots because the phenomenon has been known to transform itself into a catch-22. Historical regulatory attempts by government agencies (intended to help struggling consumers by bringing inflation down) have in the past actually increased unemployment and further slowed economic growth, which then deepened stagflation. In other words, when stagflation takes hold, attempts to alleviate it are known to backfire while a hands-off approach will leave the problem free to continue.Investors also respond to stagflation–some say it may have the effect of bringing down the value of stocks and bonds, which further slows economic growth. And most economists agree that there are few other tools to deal with stagflation.

What is the Misery Index?

In the 1970s, turmoil in global energy (mainly oil) markets triggered a period of stagflation in the United States, which led the American economist Arthur Okun to develop a measurement intended to express the degree of financial distress and uncertainty experienced by everyday Americans. Fittingly, Okun called his measurement the “misery index.” However, the misery index is not a complicated or esoteric summation of many economic factors or equations. It’s simply the rate of inflation added to the rate of unemployment. The higher the number, the more people can be expected to experience the “misery” of a struggling economy.

Will the United States Experience Stagflation?

Only last year, it appeared that the world was set to enter a period of economic growth and prosperity. With the COVID-19 pandemic easing and the labor market strengthening, it appeared that the economies of many countries would experience a boom like that following the flu pandemic of 1918 (which was sometimes known as “the roaring ’20s”).

The invasion of Ukraine seems to have derailed that possibility, however. The global energy scene has once again been thrust into instability, troublesome supply chain issues are lingering, and economies all over the globe are struggling to cope. Few are predicting a return to the grim conditions of the 1970s, during which America lost an entire decade to high unemployment, high inflation, and almost no economic growth. However, most experts are advising that everyone from business owners to minimum-wage workers should brace for a period of stagflation.

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