Stagflation and unemployment: a challenge for policymakers | Paul Drouin, CFP® PFP® posted on the topic | LinkedIn (2024)

FAQs

What happens to unemployment during stagflation? ›

In economics, stagflation (or recession-inflation) is a situation in which the inflation rate is high or increasing, the economic growth rate slows, and unemployment remains steadily high.

This presented economic policymakers with a new and perplexing dilemma since unemployment and inflation usually do not coexist. The problem with stagflation was the pain of its options. To attack inflation by reducing consumer purchasing power only made unemployment worse. The other choice was no better.

Stagflation is a real problem for policy makers because the Central Bank can increase interest rates to reduce inflation or cut interest rates to reduce unemployment. It cannot, however, do both at the same time.

The term stagflation combines two familiar words: “stagnant” and “inflation.” Stagflation refers to an economy characterized by high inflation, low economic growth and high unemployment. The U.S. has only experienced one sustained period of stagflation in recent history, in the 1970s.

Stagflation is a situation where the economy is not growing, but prices are rising, and there is high unemployment. Stagflation is generally considered worse than a recession because it is a much more challenging economic condition to manage.

Stagflation and stock prices

That's why the companies who benefit from stagflation are those who offer these indispensable products—so-called “defensive companies.” When stagflation occurs, their shares increase in value, as is currently the case with many energy providers.

When stagflation occurs, don't panic, sell your stocks and bonds and invest in rare art, gold, or other unusual commodities. Stagflation is not a good reason to completely abandon a sound investment strategy.

Stagflation is a combination of three negatives: slower economic growth, higher unemployment, and higher prices. This is a combination that isn't supposed to occur, in the logic of economics. Prices shouldn't go up when people have less money to spend.

Stagflation in the 1970s was a period with both high inflation and uneven economic growth. High budget deficits, lower interest rates, the oil embargo, and the collapse of managed currency rates contributed to stagflation.

Traditional monetary policies can now be seen to combat one economic turmoil or the other, for example, rising prices or high unemployment, but are difficult to combat stagflation because of the opposite direction changes in interest rates have on such factors, such as slow growth and rising prices.

What are the risks of stagflation? ›

Stagflation is an economic scenario characterised by stagnating economic activity and high unemployment, while inflation is high and sustained over time. This can lead to a situation in which the economy does not grow and people lose the necessary purchasing power to cope with inflation.

To escape stagflation, the Federal Reserve accepted that they had to choose combatting inflation or unemployment alone and let the other suffer, at least for the short term, to rectify the economic situation. The Reserve went with inflation and slowly worked to raise interest rates and slow monetary reserve growth.

The consequences of stagflation are: high prices on nearly all consumer goods, low wages, and abnormally high unemployment.

Tax measures: The best policy measure is to reduce income tax and corporate taxes as they tend to reduce labour costs and raise demand for labour. Similarly, GST should be reduced in order to prevent the price level from rising.

Even JPMorgan Chase CEO Jamie Dimon said last month the US economy “looks more like the 1970s than we've seen before,” and that stagflation is a growing risk. But Federal Reserve Chair Jerome Powell said any positive stagflation tests were false positives.

Inflation has historically had an inverse relationship with unemployment. This means that when inflation rises, unemployment drops. Higher unemployment, on the other hand, equates to lower inflation.

The effects of deflation

Here are a few. Falling incomes/higher unemployment: When businesses are selling goods for lower prices, they earn less profit. To make up for it, they may cut wages or lay off employees, and spend less on innovation and investing in the company.

Diversifying your portfolio across stocks, real estate, gold and other assets can minimize your risk during stagflation. Real estate and gold can also help hedge against inflation. As inflation increases, real estate and gold also rise in value because of their limited supply and their value to society.