It is looking increasingly likely that stagflation could become a risk to the economy, not since the 1970's have conditions been more conducive to a sustained stagflation period and this time, it will be on a global scale.
Runaway inflation is currently being experienced throughout the world’s economies causing a cost-of-living crisis and economic slow-down.
Growth is faltering, caused largely by the increased strain on supply chains due to the Ukraine conflict, the aftermath of covid and the limited options central banks have to remedy the situation. Add to this, the inevitable job losses an economic downturn will cause and stagflation becomes a real possibility.
We are now all too familiar with the boom-and-bust business cycles and lurching from one financial crisis to another, and most will be familiar with the following economic terms;
Inflation: The rate of increase in prices of goods and services over a given time, increase in the cost of living due to production cost rises and demand. This gives money less purchasing power.
Deflation: The reduction of general level of prices which often occurs in times of high unemployment. Deflation is caused by decline of aggregate demand along with increase in aggregate supply.
Reflation: The first phase of economic recovery by a monetary policy to expand output, stimulate spending and curb effects of deflation.
Recession: Typically defined by three consecutive months of economic contraction or a general decline in economic activity. Recession is caused by losses in economic activity due to a loss in consumer confidence or a drop in disposable income which leads to a decline in demand for goods and services.
Depression: A sustained period of economic recession sometimes lasting years characterised by high unemployment levels, plummeting house prices and bank failures.
But what Is stagflation?
Whilst economist’s opinions differ on exactly what stagflation is and what causes it, it can generally be described as a phase of low economic growth, together with high inflation, which leads to an increase in unemployment.
Stagflation occurs when the supply of money is expanding, but the supply of commodities such as oil are constrained or their prices are rising sharply.
Slow economic growth will almost always lead to higher unemployment but not to increasing prices. However, when high INFLATION coincides with an economic slow-down then the result is a STAGNANT economy hence the term stagflation.
Many economists consider stagflation to be an even worse prospect for any economy than a recession as it combines the negative effects of recession with rising prices. Tackling stagflation is particularly tricky for central banks because the traditional steps they may take to reduce inflation such as increasing taxes and interest rates or reducing spending / money supply will often worsen the unemployment problem and further slow the economy.
When could stagflation happen?
Since the beginning of the year, experts have been warning of possible stagflation. The economic problem will occur if inflation continues to rise. It is difficult to pinpoint exactly when this might be the case, however, global economic growth is so far, weaker than was expected for 2022, therefore stagflation could be on the horizon.
In order to lower their exposure to risk, investors are being advised to watch the markets closely and consider portfolio diversification.
Defensive assets will prove popular
Investors are more likely to lean towards defensive assets as a wealth protector if/when stagflation does occur, they are commonly turned to in the event of economic crises as they serve as a kind of safety net, with the risk level being lower than other investment types.
Gold is a good example that is likely to see a price hike in the event of stagflation. Gold, as an asset offers a high rate of return to investors and is considered to be more valuable than cash, especially during times of economic crisis.
Investors will seek to diversify their portfolios
Many investors protect their wealth against stagflation by diversifying their investment portfolios. So, they may move towards expanding their portfolios and putting money into lower-risk investments. This could spark market volatility as investors buy and sell their shares in stock.