Stagflation is a macroeconomic environment in which the inflation rate is high, the economic growth rate is negative, and the unemployment rate is high.
Stagflation is a term used to describe an economy that is stagnant and experiences little to no economic growth but is experiencing high inflation. Such an environment is bad for both bonds and stocks.
Signs of stagflation include high rises in the price of consumer goods and services through high inflation, a reduction in Gross Domestic Product (GDP), and high unemployment.
Stagflation is a period in time when there is a combination of high inflation and economic stagnation.
In essence, it is characterized by rising unemployment and declining business production while the prices of goods and services get higher.
Both stagnation and inflation magnify each other, causing economic conditions to worsen further.
One of the worst things that can occur to a currency is the effect of stagflation.
It leaves very little room for central banks to move because they cannot raise interest rates enough to combat rising prices.
When prices rise disproportionately to interest rates, the value of the domestic currency depresses.
This, in turn, reduces the purchasing power of consumers.
As such, foreign exchange markets usually see stagflation as negative for the domestic currency.
What causes stagflation?
There is no consensus among economists on the causes of stagflation. However, two main theories may be derived: supply shock and poor economic policies.
The supply shock theory suggests that stagflation occurs when an economy faces a sudden increase or decrease in the supply of a commodity or service (supply shock), such as a rapid increase in the price of oil.
In such a situation, prices surge, making production costlier and less profitable, thus slowing economic growth.
A second theory states that stagflation can be a result of a poorly made economic policy.
For example, the government can create a policy that harms industries while growing the money supply too quickly.
The simultaneous occurrence of these policies can lead to slower economic growth and higher inflation.
What is the difference between recession and stagflation?
A recession is a sustained decline in economic activity.
Stagflation is a sustained decline in economic activity combined with sustained high inflation.
What is the difference between stagflation and inflation?
Inflation is defined as the rise of the overall prices of goods and services over a certain period of time.
Stagflation is a combination of high inflation and negative economic growth.