Stagflation is like an imperfect storm, a weather situation with many contributing factors. Stagflation is an economic condition caused by a combination of rising inflation and high unemployment rates, causing a decline in consumer demand for goods and services.
In a good economy, there is an equilibrium, where slow, steady economic growth is in line with consumer demand. With stagflation, the economy is out of balance in a bad way.
What does stagflation mean?
Stagflation occurs when high inflation is accompanied by high unemployment. Despite recent growth in unemployment rates, the country is still about 2 million jobs shy of employment in the days leading up to the pandemic.
The pandemic also created problems that contribute to stagflation, such as supply chain problems. Lack of product contributes to inflation because rising prices result from consumers competing to buy from an insufficient supply.
To understand stagflation, economists look at the whole picture.
Is stagflation a recession?
What is stagflation compared to recession? Unfortunately, and alarmingly, there are levels of stagnation. In the worst case, it is an economic cycle that can lead to a recession. Economic policy actions are being taken to counter stagflation, such as raising interest rates, as the Federal Reserve did in May and again in mid-June 2022.
But when the federal reserve raises interest rates in an effort to fight inflation, it could exacerbate unemployment rates — as employers fight to run their businesses while facing higher costs. When inflation rises and the federal reserve approves rate hikes, a period of stagflation sets in. Stagflation at its worst is a recession.
Stagnation vs Inflation
High inflation and unemployment influence each other. Higher inflation means that the purchasing power of consumers decreases. They have less money to spend. When the money supply for consumers is tight – in other words, when their dollars don’t go that far – they pull back on their spending.
That puts pressure on companies. During periods of inflation, which lead to stagflation, no real economic growth can take place. Economic research has shown that companies put growth plans on hold during such times. Companies are also facing price pressures as their supply, utility and debt costs rise.
Stagflation vs Economic Stagnation
Economic stagnation is a period of no economic growth. It is a stage of stagflation, characterized by higher prices for goods, including raw materials that companies need, and services. Many economists agree that the longer periods of economic stagnation, the greater the likelihood of a recession.
What Causes Stagflation?
Most economists define stagflation as caused by these five factors:
Negative GDP growth
GDP is the Gross Domestic Product, which is a measure of the country’s domestic production. Supply-side economists take inflation into account when calculating real GDP. Over the past 2 years, GDP has fallen due to slow economic growth. Higher GDP growth indicates a healthy economy.
Unemployment rates have fallen since pandemic restrictions eased, but the economy has not returned to pre-pandemic employment rates. At the same time, small businesses were largely unable to compete for workers compared to the higher wages medium and large businesses could offer. The unemployment rate is low, but the US still has 2 million fewer jobs than its pre-pandemic level.
The pandemic caused supply shocks throughout the supply chain, from production to delivery. As the economy faced a lack of inventories, higher demand for items threw price controls out the window. Supply chain problems contributed to the rise in inflation.
The Federal Reserve raised interest rates in hopes of preventing inflation from reaching double digits and stabilizing the economy. Inflation contributes to stagnation as consumers and businesses have less money to spend. Discretionary spending decreases as money is set aside for necessities, such as financial obligations and utilities. If the Fed raises interest rates, central banks respond quickly by raising interest rates as well.
High prices are part of inflation. Inflation affects companies, who pay more for supplies and utilities. Their customers face the same challenges and cut spending.
Stagflation and economic growth in the US
It’s not like stagflation is something new. It can be part of the economic cycle in any government. In the 1970s, the US experienced a period of stagflation. Then-President Richard Nixon introduced a monetary policy that frozen wages and prices for 90 days and imposed a 10% tax on imports. Stagflation still bottomed out with a national recession.
How stagflation affects small businesses
Consumers and small businesses are suffering from stagflation. Here are the main ways:
Small businesses pay more for supplies, utilities and financial obligations. Those costs are passed on as higher consumer prices, because companies are forced to raise prices. It’s a trade-off.
Rising oil prices
Oil and petrol/diesel price increases have reached historic levels. Inflation for oil and petrol/diesel is staggering. The country is facing an oil crisis, with the winter months just around the corner.
Although unemployment rates are falling, the country still has about 2 million jobs below pre-pandemic levels.
Rising interest rates
When the Federal Reserve raises interest rates, the central bank responds to raise interest rates. The cost of borrowing capital is rising for small businesses. Many small business loans have variable interest rates. Rising interest rates increase the amount of monthly payments.
Supply chain issues
These problems will continue as manufacturers struggle to source raw materials and also bear the cost of supplying the materials.
As prices rise, consumers are reducing their spending habits, especially for luxury items.
Preparing for stagflationRefinance any floating-rate loanBuy a business credit card with an interest-free introductory rateFocus on customer relationshipsFocus on supplier relationshipsPivot the businessLimiting expenses, such as travel
How does stagflation end?
There are three conditions that make up stagflation: flat job growth, no wage increases, and a stale stock market.
Changes in economic policy can slow down stagnation and potentially help turn the economy around. If the three conditions worsen, stagflation ends with depression.
Image: Envato Elements
This post What is stagflation? – Small Business Trends was original published at “https://smallbiztrends.com/2022/06/what-is-stagflation.html”