Stagflation is a rare event when the economy is somewhat “dead in the water” while the inflation rate is increasing, and unemployment is pretty high.
Stagflation is uncommon, but it has recently been brought as a topic of speculation. In June 2022, the World Bank cautioned that stagflation risk has gone up because global economic growth has sharply slowed down and inflation has hit multi-decade highs.
It remains uncertain whether the US economy is set to face its second stagflation, following its first in the 1970s. Still, it’s vital to understand the current situation together with the country’s notable period of stagflation in the 1970s.
Stagflation Explained
Stagflation is a combined term from the words stagnation and inflation occurs. While it has no exact definition, stagflation is often observed when inflation in the economy is high, while economic growth is losing momentum, and the unemployment rate stays relatively high.
Usually, when prices rise fast, the aggregate demand outperforms the aggregate supply, and the economy expands, resulting in demand-pull inflation. In such a situation, consumers receive more income which in turn increases their spending on products and services.
During stagflation, the circumstances are reversed. Less supply is raising prices, but people lack sufficient income to spend, making it pretty tough to cope with higher prices.
In other words, a period of stagflation puts the economy at a disadvantage as it reduces the overall spending power. Include higher prices to that mix, and the outcome weighs the economy further down as the value of consumers’ money gradually declines.
Moreover, as periods of stagflation hardly ever occur, it requires a rare event to cause a situation where the economy cannot perform well, and inflation is high.
Managing Investments During Stagflation
Investors are facing two headwinds at the moment: high inflation and surging interest rates. Two factors that are not exactly providing market players with a clear direction as to where they should go with their investments.
Such is a challenge for them since many things that would have usually performed effectively in a slower economy are not doing well. It’s giving you some tricky options and decisions.
That is why it’s crucial that you’re strategic and careful with readjusting your investment portfolio. For example, suppose you’re dealing with a significant purchasing decision such as a car. In that case, you need to determine whether you can defer or postpone buying the item where its price may be temporarily high.
You should also keep yourself updated about the core data and related news reports. As an investor, you need to consider expectations as much as facts.
Lastly, while the economy is widely expected to slow or even contract, you should pay more attention to slight changes to your asset allocation instead of the broader ones. Stay calm and rational and stick to the plan.
While inflation is not looking too good right now, the US economy is largely different today from how it was in the 1970s, showing more signs of momentum and strength than stagnation.
