You may have recently heard of the term ‘stagflation’ which is becoming an increasingly discussed phenomenon in the media. This article will outline what stagflation is, how it works and what this could mean for you and your financial circumstances.
What is stagflation?
Stagflation occurs where inflation rates continue to rise during a period of stagnant economic growth and high unemployment. The reason why it may have some investors on edge is that inflation is not supposed to rise in a weak economy. Inflation rises more steadily and is slowed down in a normal market economy and therefore stagflation only occurs where government policies and legislation interfere with normal market conditions. The result of this is that governments or central banks increase the money supply at the same time they constrain supply.
This occurred during the pandemic whereby the Federal government was providing additional stimulus packages whilst also circumventing the circulation of money in the economy due to the restrictions in place which limited consumer spending. It can also occur where governments print currency or central banks create credit, at the same time governments may increase taxes and raise interest rates to reduce additional spending. When these conflicting policies are operating simultaneously it can slow growth whilst creating inflation and hence cause stagflation.
How is stagflation measured?
Stagflation is measured according to a variety of factors over a period of time. The two main indicators include an increase in prices as well as an increase in the rate of unemployment. Although an increase in one of these factors may not always suggest stagflation, they often occur in conjunction with one another. A rise in prices is likely to be reflected in an increase in the Consumer Price Index (CPI) and the Producer Price Index (PPI). CPI measures the percentage change in the price of a basket of goods and services consumed by households. Whereas PPI measures the price of a basket of goods and services typically purchased by produces and is reflective of the cost pressures faced by businesses. To read more about how inflation may impact your investments, click here.
Stagflation may also be reflected in a decline in a country’s gross domestic product or GDP. GDP is the market value of all finished goods and services produced within a country’s borders in a specific period. In a strong economy, this number should be increasing to indicate the productivity occurring within a country.
What causes stagflation?
There are a few main reasons that have been associated with causing or leading to stagflation. They include:
- Surging costs for consumer goods
- Rapid growth in the money supply
- High taxes and excessive regulation of businesses
- Excessive welfare allowing people to survive without working
However, the exact force that creates stagflation is not exactly known.
Will stagflation impact my investments?
There will always be external market forces that have the potential to impact an investor’s finances, and this includes stagflation. One potential way for individuals to reduce the negative effects of stagflation on their financial position is to remain disciplined to a long-term investment strategy.
It is important that investors do not react to short term noise and sell all their shares and bonds during stagflation due to a short term fall in the value of their investments. However, ensuring that your portfolio is sufficiently diverse will assist in reducing the impacts of short-term volatility, and therefore you may want to revise your current levels of risk.
Stagflation is likely to be a short-term phenomenon in comparison to a long-term investment strategy and thus it is a good idea for investors to continue with their long-term approach and continue with the regular purchasing, saving and investing habits they have in place.
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