Stagflation 2.0: Will it affect us?

Stagflation

by Sonia Boolchandani Last Updated: 2022-06-21T19:19:48+05:30


One word that has been buzzing a lot these days is Stagflation. Inflation suna tha, deflation suna tha, ye stagflation kya hai ? And why is everyone saying that we could witness the Stagflation now just like we did in the 1970s

Amidst this bear market, if anything good is happening with me is, that is I am adding new words to my vocabulary! 

Anyways, Stagflation is basically an amalgamation of two words, Stagnant and Inflation, it is a state where the economic output is stagnant and the inflation is high.

If it all went over your head, don’t worry! I'll simplify it for you.

In simple terms, there are three things that reflect the health of an economy, GDP ( Gross domestic product), which is basically the value of all goods, and services produced in an economy, Unemployment, and Inflation, which is nothing but the level of rise in the prices of products a.k.a Mehengai in a country!

All three things are looked at by economists to understand the health of an economy, now these things are more or less interlinked to each other, more often you will see high GDP, with less unemployment, which would be balanced by high inflation.

Because if the output in a country is increasing, it means the production is increasing and the number of people employed in an economy would increase, and similarly high GDP is a result of strong demand and high demand for products lead to high prices and inflation.

In a similar way, a weak GDP is accompanied by high unemployment and low inflation.

So in both cases, there is some good news and some bad news to counterbalance each other, but when their stagflation there is no good news!

The economic output reduces as well as the inflation is high. But how can it happen? 

Because generally inflation and unemployment are negatively correlated, if the unemployment is high, people would have lesser money in hand to spend and hence the inflation would be low. But In 1970, we witnessed stagflation in the USA, where the economic growth is stagnant, unemployment is high and inflation is also high.

What Causes Stagflation?

There are two things that cause Stagflation, the first is poor fiscal policy, and the second is supply-side shocks. Supply-side shock is anything that reduces a country’s ability to produce goods and services for ex. during the pandemic, we witnessed a shortage of raw material, and labor, these all things are supply-side shocks.

The stagflation of 1970 in the US is a prime example of that. In 1970, post world war 2, the US was facing intense competition from foreign nations, also, due to the expensive Vietnam war, the economy was in a bad shape. The inflation was high, there were fewer jobs, so the then president Richard Nixon undertook a series of measures like a 90-day freeze on wages and prices, A 10% tariff on imports, and The removal of the US from the gold standard. All these actions resulted in Stagflation, the federal reserve raised interest rates to fight inflation, which resulted in a recession.

All these irrational actions resulted in Stagflation and if you thought this was it, you are wrong. At the same time, the Organization of Petroleum Exporting Countries (OPEC) did an oil embargo on the US, which in layman terms means they stopped supplying oil to the US, due to which the prices of crude oil skyrocketed and inflation in the US reached an all-time high.

It took a decade for the US to recover from the Stagflation.

So, the instance of the 1970s shows that supply-side shocks coupled with poor fiscal policy cause stagflation. Now, the question are we going to experience the Stagflation?

To understand that let’s compare the current economic conditions with that of 1970.

Is inflation high?  Yes, Absolutely.

Are the crude oil prices high as they were in 1970 to induce inflation? Yes

War in Russia-Ukraine has caused the supply-side shocks and the inflation in most countries is at an all-time high.
 
Is the GDP declining and Unemployment increasing? No.

As in its latest State of the Economy report, Reserve Bank of India (RBI) staffers noted: “Gross domestic product (GDP) for 2021-22 surpassed its pre-pandemic (2019-20) level by 1.5 per cent and activity is gaining strength in 2022-23 so far as gauged from high-frequency indicators."


Also, as a recent Bloomberg report put it, "The world economy has a decent shot at escaping a full re-run of 1970s-style stagflation—and that’s about as far as the good news goes."


With our economy on the path of growth and correct measures by RBI to control inflation, India may not witness stagflation, but with rising interest rates in the US, the fiscal deficit could widen and India may face financial instability issues.
 
 
 
 

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About the Author

Sonia works as finance content creator with 5 paisa. She has two years of experience as finance content creator. She loves writing business stories and analysing companies.

 

 

 

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