What Is Stagflation, & Why Is It Bad? A Simple Explanation
What happens when prices of basic goods such as food and fuel rise while income growth declines, or remains neutral?
For most people in the population, it’s just another day in the life of our Covid reality.
But economists have a fancy name for it: Stagflation.
Stagflation is simply the clever combination of “stagnation” with “inflation”.
Stagnation here refers to economic stagnation, where growth is either weak or non-existent.
Inflation refers to the rise in prices from factors not associated with the “good kind” of inflation.
This is due to the ongoing stagnation, which precludes high levels of aggregate demand and hence a general rise in prices due to virtuous economic factors like income growth and higher consumer spending.
Instead, the inflation component of stagflation is a result of some kind of shock that causes prices to rise.
Unfortunately, this is the economic reality in many parts of the world today, which are still struggling to emerge from the pandemic’s long shadow. Their domestic economies remain hamstrung by the effects of past lockdowns, if not lockdowns that are still continuing, with many businesses closed and people out of work.
Labor markets in poor health, combined with an outlook for the future that is still tremendously uncertain is not a recipe for robust economic growth.
Money is saved, discretionary purchases curtailed, and liquid assets hoarded. This leads to the stagnation part of stagflation.
The inflation portion comes from Covid lockdowns’ deleterious effects on essential global markets.
As such, stagflation is not a desirable scenario, as prices of basic goods rise, but because economic growth is weak, people’s incomes are not rising along with prices.
This creates a situation where consumers’ levels of disposable income falls, simply because essentials such as food and fuel (transport/heating/electricity) must be paid for.
This leaves households with less money left in their pockets for spending on other things, for e.g. leisure.
Consequently, whatever meager amounts are left after purchasing essentials are saved instead of spent.
This saving, when done simultaneously by the majority of households, severely reduces the amount of spending in the economy as a whole.
Unfortunately for everyone involved, this then creates a negative feedback loop.
Since the spending needed to jolt the economy back into some form of sustainable recovery does not occur, households are encouraged to keep saving. This further reduces spending, and encourages even more saving, leaving the economy unable to grow out of what is now a stagflationary quagmire.
This self-perpetuating nature of stagflation is what makes it so pernicious, and is also what keeps economists and policymakers awake at night.
Given how the pandemic and governments’ responses to it have played out through 2020 and early 2021, they have plenty of reason to be.
Do You Want To Make Money Trading?
Learn how to, and more, in our Trading Courses.