Key learning points
- The US experienced stagflation in the 1970s, the only time in our history.
- While we are not officially in a recession, there are growing concerns about what the ongoing rate hikes will do to the economy.
- A recession and stagflation are bad news, but stagflation is worse because it means we are dealing with high inflation and high unemployment rates.
We’ve all heard a lot about the possibility of a recession lately, but another lesser-known possibility is stagflation, although it’s rare for high inflation to be accompanied by high unemployment. Fortunately, the US economy only experienced stagflation once in the 1970s, when the economy suffered under very unique circumstances.
While we’re not technically in a recession right now, it certainly feels like we’re not far from it. According to economists, the resilient labor market has helped us avoid an official recession. There are growing concerns about how continued Fed rate hikes will affect unemployment rates. There are fears that as the cost of borrowing is rising, companies will have to lay off workers, which would hurt the labor market and potentially send us into a recession.
If high inflation is accompanied by high unemployment and a slowdown in economic growth, we could experience stagflation for the second time in history. We’re going to look at the differences between stagflation and a recession so that we can better understand these key economic terms.
What is stagflation?
Stagflation is a term that was introduced to the general public in the 1970s. It refers to a unique period when unemployment and inflation are high, but economic growth is stagnant.
The actual word ‘stagflation’ is a contraction of ‘stagnation’ and ‘inflation’. You could say that stagnation in GDP growth due to high inflation leads to stagflation.
Economists initially did not believe that a situation known as stagflation was possible, as unemployment and inflation tend to move in opposite directions rather than increase simultaneously. Now it is known that while stagflation is rare, it can have a devastating impact on the overall economy as we experience a recession with inflation still high.
It is challenging to find a general consensus of economists on what could be causing stagflation. Stagflation can be attributed to extreme shocks in the food or energy supply, rapid expansion of a country’s money supply, and poor government economic policies.
What is the history of stagflation?
When did the US economy first experience stagflation? Until the 1970s, stagflation was never documented in history. Thereafter, the US faced a 9% unemployment rate, a slowdown in economic growth and double-digit inflation.
Some experts say the stagflation in the 1970s was the direct result of poor policy decisions that led to higher inflation accompanied by the supply shock of an oil embargo, a near-perfect storm for this unique economic situation.
During the early 1970s, the US economy began to feel the impact of the expensive Vietnam War and the slowdown in the boom after World War II. President Nixon tried to resolve the situation by devaluing the dollar and announcing a freeze on wages and prices.
In 1973, oil-exporting countries cut off US supplies with an oil embargo that had immediate effects on the economy. All this was combined with the high budget deficit resulting from the spending on the Vietnam War. From then on, the economic problems only got worse as inflation and unemployment reached 5% each year from 1974 to 1982. Although the oil embargo was the cause of the devastation of the supply chain, President Nixon’s actions contributed to a dire financial situation.
Many who have written about this unique case of stagflation believe that the Fed will try to act quickly when it comes to containing inflation in the future, as there have been two difficult recessions during this painful period of high inflation.
Why are there concerns about stagflation now?
While we haven’t seen stagflation since the 1970s, there are concerns that it may resurface. In late 2021, The World Economic Forum revealed how Google searches and conversations about stagflation were creeping up on rising oil prices and global supply chain problems.
The pandemic recovery has created a unique scenario where economic growth has stalled as inflation rises. The global economy and demand recovered strongly as pandemic restrictions were eased, and we were not ready. To make matters worse, Russia invaded Ukraine, leading to even more unprecedented supply chain problems and problems with rising oil prices.
What is a recession?
There is an official definition for a recession and a process for declaring an official recession. The textbook definition of a recession is two consecutive quarters of declining GDP.
When it comes to the official declaration of a recession, the National Bureau of Economic Research (NBER) is responsible for making the call. The organization does economic research and they have a complex set of criteria that they consider.
We have experienced 11 recessions since 1948. The shortest recession occurred in 2020, when the pandemic officially began. Recessions naturally occur in an economic cycle because we go through periods of expansion, which eventually lead to periods of contraction. Recessions then occur as a result of a specific trigger or unforeseen shocks. The 2009 recession was the result of the bursting of the housing bubble, while the 2020 recession was directly caused by the sudden COVID-19 pandemic that shut the world down.
Why was there no recession declared?
While many economists have expected an explanation of an official recession, it has yet to happen. The reason for this is that NBER economists argued that the labor market has remained resilient, keeping the economy afloat for now. The NBER also confirmed that GDP fell due to inventory issues caused by unique supply chain problems.
We have to wait and see how the Fed rate hikes will affect the economy. There is a risk that the rate hikes could pull us into a recession. According to the Fed, unprecedented dynamics are at play since there is an ongoing war in Ukraine and various supply chain concerns. Despite this, central banks will continue to raise interest rates, even with the threat of a recession on the other side of these rate hikes. Federal Reserve Chair Jerome Powell recently admitted that a soft landing is unlikely and a recession is inevitable.
How do you know if it’s a recession or stagflation?
Unfortunately, the effects of stagflation and recession are being felt long before an official announcement is made. And while a recession is predicted to last an average of ten months, stagflation is a terrible phenomenon that can last for many years, as was experienced in the 1970s.
Stagflation is rarer than a recession as inflation occurs naturally in our economic cycle. Many experts believe that stagflation is the worst-case scenario, as it is accompanied by slow economic growth coupled with inflation, pushing prices up for an extended period of time.
The worst part about stagflation is that families will have to deal with higher interest rates and higher prices, while fears of job cuts hover over them.
How should you invest your money?
During a recession or stagflation, it can be difficult to find investments that deliver positive returns. While it is difficult to say for sure what the future holds for our economy, the signs are clear that the economic downturn will continue as the central bank continues to raise interest rates to cool inflation. For investors, it can be challenging to find assets worth putting your money into for fear of your portfolio going into the red. At the same time, it is difficult to sell if you already have investments, because the markets can recover quickly and have already fallen a bit.
We realize that even in the best of times, investing in the stock market is risky and often stressful. For a simpler approach, check out Q.ai’s Inflation Kit and protect your investments from depreciation. In fact, you can activate Portfolio Protection at any time to protect your gains and reduce your losses, no matter what industry you invest in.
When high inflation is combined with a period of stagnant growth in the economy, there is pain in many sectors. However, a recession or stagflation will not affect every sector equally. While we wait for an official statement of a recession, we must look for investment opportunities that could survive an economic downturn as we all brace ourselves for what may come next.
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