The global economy is going through a period of high inflation. India’s inflation has been above the Reserve Bank of India’s targeted range for five months. The US CPI is at a four-decade high. The world’s largest economy contracted 1.4% in Q1 2022. GDP contraction and high inflation is causing speculation about whether the US economy is entering a period of stagflation.
But What Exactly Is Stagflation?
Stagflation is a simultaneous period of high inflation and slow growth. Rising unemployment means a possible loss of income. Those who manage to retain jobs see their purchasing power curtailed as prices of essentials increase.
The first description of stagflation was in the 1960s as a “stagnating situation.” The term’s first usage happened in the US in the 1970s when the economy saw negative GDP for five straight quarters. US inflation doubled in 1973 and hit double-digits in 1974. The unemployment rate in 1975 was 9%.
The current unemployment rate in the US is 3.6% which is at pre-pandemic levels, prompting economists to not term the current situation in the US as “stagflation.”
What Causes Stagflation?
Government overprinting currency is one of the biggest causes of stagflation. The US Federal Reserve printed $3T between March-June 2020 and another $325B in 2021. The practice, known as Quantitative Easing, was done to keep long-term interest rates low and boost economic growth.
Excess liquidity in the system leads to inflation, which the US economy is witnessing. The US Federal Reserve has embarked on a rate hiking cycle and winding down its balance sheet.
A sudden supply shock or a sudden increase or decrease in supply is another factor that can trigger stagflation. Crude oil prices spiked earlier this year after Russia invaded Ukraine. Brent prices remain above the $100 mark. The world is also grappling with supply chain issues. Shortage of critical components across industries and higher oil prices have sent input costs soaring. High input costs impact the profitability of companies.
Previous Instances Of Stagflation
There have been two prior instances of stagflation in the US economy. One was between 1974-1975, and the other was between 1978-1982. Both periods overlapped a recession in the US.
Zimbabwe saw stagflation in 2018 and 2019 when a series of economic shocks caused the government to print excess money as economic output declined.
A World Bank report in June talks about the rising risk of stagflation with potentially harmful consequences for middle-and-low-income economies. Amidst such volatility, all investors can do is follow the age-old adage – “Buy Right, Sit Tight.”
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