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Understanding the Differences Between Inflation, Deflation & Stagflation

Unemployment reduces consumer demand and slows economic growth. In other words, Nixon’s three attempts to boost growth and control inflation had the inverted head and shoulders pattern opposite effect. Typically, inflation goes hand-in-hand with economic growth, and an overheated economy is one possible cause of higher inflation.

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  • Stagflation happens when growth slows, demand falters, unemployment rises — and almost contradictorily, inflation keeps climbing.
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  • The de facto consensus on stagflation among most economists and policymakers has been to essentially redefine what they mean by the term inflation in the era of modern currency and financial systems.
  • People warned of the risk of stagflation if inflation worsened and the economy didn’t improve.

“I think we’re going to see higher interest rates to reduce demand — reduce demand by companies, reduce demand by consumers.” On rare occasions, however, high inflation persists even as the economy slows and unemployment rises, resulting in stagflation, she said. Last year saw big crowds, congested highways and full airplanes as tens of millions of Americans celebrated their own liberation from the pandemic. There were worries that creeping inflation would keep people home as the price of gas, meat and just about everything else ticked up — but the pessimists would not be vindicated. Inflation, after all, isn’t always bad — and it’s far from the only economic phenomenon that involves changes in the cost of stuff and the value of money.

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They worried that the Fed’s expansive monetary policies, used to rescue the economy from the 2008 financial crisis, would cause inflation. Instead, it was a combination of fiscal and monetary policy that created it. However, the two most dramatic numbers economists and politicians watch when evaluating economic stagnation are gross domestic product (GDP) and unemployment. When weighing big purchasing decisions—like a car, for example—consider whether you can defer or delay the purchase of items where prices may be temporarily elevated, he adds. McMillan argues that based on the 1970s definition, the U.S. could have experienced stagflation—there was a supply shock caused by pandemic-related supply chain issues and a significant increase in the money supply due to the Fed’s policies. In general, the stage is set for stagflation when a supply shock occurs.

The higher interest rates climb, the more of a concern it’s becoming, especially as inflation doesn’t look like it’s slowing down completely. Cooling gasoline prices have helped to take the edge off of inflation, but prices are heating up in key areas of rent, housing and medical care despite 3.75 percentage points of rate hikes so far this year. The steepest inflation in four decades and severe product shortages have evoked comparisons to the economic doldrums faced by the U.S. in the 1970s.

Stagflation is an economic cycle characterized by slow growth and a high unemployment rate accompanied by inflation. Economic policymakers find this combination particularly difficult to handle, as attempting to correct one of the factors can exacerbate another. One obstacle in the way of a stagflationary re-rerun is the modern global economy’s significantly reduced dependence on energy to generate growth.

What causes stagflation?

“You’ll win on your mortgage repayment if inflation continues or rises and be protected on your Treasury bond investment with one big caveat — the inflation protection is taxed,” Kotlikoff explains. Credit cardholders who carry a month-to-month balance should consider transferring that costly debt to a balance transfer card. Many of these cards offer an introductory 0% APR period of up to 21 months which can help you make a sizable dent in your debt without any additional interest accruing.

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Instead, present-day inflation is owed to generous central bank and Congressional policies in response to the pandemic, which flooded the economy with money, spiked demand and exacerbated a supply chain bottleneck, Harvey said. Moreover, the price crunch has intensified amid the Russian invasion of Ukraine, he added. But many have offset the damage, at least in part, with wage increases driven by high demand for workers and resilient consumer spending. In short, strong pockets of the economy have blunted the worst effects of severe inflation. Inflation and unemployment are supposed to have an inverse relationship, making it easier for central banks to manage things by adjusting interest rates. But if this is how the economy is supposed to work, stagflation is a puzzling paradox.

Businesses are humming along, profits are up, and people have more money to spend—so consumer demand causes prices to increase. Those supply shocks are also often what causes unemployment to counterintuitively rise when inflation is also high. Supply shortages reduce the productive capacity of an industry, leading to fewer jobs in that sector as well as higher prices. That’s out of the ordinary because joblessness doesn’t typically bode well for growth, and when demand takes a nosedive, so can inflation. Businesses likely push back investments; consumers are either spending less or have limited amounts of money to fund their purchases.

Supply Shock

McMillan says that paying attention to both the underlying data and the headlines is important. “If you’re an investor, you need to play off expectations as much as reality,” he says.

When demand is high — as it is during a booming economy — then prices go up. Even though the Fed is left having to counteract supply shocks it has no control over, monetary policy will be key to keeping history from repeating itself. The OPEC oil embargo in 1973 and a drop in oil production after the 1979 Iranian revolution bookended the decade. After oil-exporting Arab nations stopped exporting oil to the U.S., the price at the pump quadrupled, and oil was in short supply. High energy prices drove up the cost of producing goods and slowed the economy.

Stagflation is a great example of how real-world experience can run roughshod over widely accepted economic theories and policy prescriptions. “By early summer, investors looked increasingly confident that the global economy was escaping the plague of stagflation,” analysts at Generali Investments said in a research note published Thursday. Brent crude futures have jumped more than $20 a barrel in the three months to late September, a rally that has put a return to $100 sharply into focus. The international benchmark was last seen trading at $96.12 on Friday, up 0.8% for the session.

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A big part of this also depends on how unemployment numbers unfold in the coming months. If you’ve heard the predictions that the economy is headed for a recession, don’t freak out. While disco and bell-bottom jeans were all the rage, there was a toxic combination of events and economic factors that led to a period of stagflation (dun-dun-dun).

The most notable case of stagflation took place in the 1970s, afflicting most Western economies. Doug is a Chartered Alternative Investment Analyst who spent more than 20 years as a derivatives market maker and asset manager what is a momentum stock before “reincarnating” as a financial media professional a decade ago. Karl Montevirgen is a professional freelance writer who specializes in the fields of finance, cryptomarkets, content strategy, and the arts.

There won’t be an economic litmus test per se to measure whether stagflation is occurring. Another way of looking at it could be that there could or would be differing degrees or flavors of stagflation. Economists in Bankrate’s Third-Quarter Economic Indicator poll see joblessness rising to 4.4 percent by October 2023. We’re transparent about how we are able to bring quality content, competitive rates, and useful tools to you by explaining how we make money. “This is the absolute time for people to batten down the hatches and beef up the foundation of their financial house,” Jenkin said.



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