Stagflation

Was first observed in the 1970s in the US market. Stagflation at face value is often described as a period of high inflation, unemployment, and low demand & GDP growth. In this blog post, we are going to address the following queries about stagflation.

  1. What is Stagflation?
  2. What causes Stagflation?
  3. Stagflation vs recession?
  4. Is Stagflation worst than recession?
  5. How to invest during the period of stagflation?

What is Stagflation?

Stagflation happens when we have a period of negative GDP growth being accompanied by high inflation. Usually, in an economical downturn, prices for goods and services tend to cool down due to decrease spending from consumers. However, in Stagflation, consumers would not only experience a loss of economical output but an eroding purchasing power from their savings. This causes a serious dilemma for the consumer. Raises the important Question: “Should I save or spend?”. 

Why economists/Central often use Core CPI instead of headline CPI?

Headline CPI includes Energy and Food prices. These two commodities are very volatile. Economists and central banks don’t react to price changes in these commodities because short-term sharp changes in energy and food prices are viewed as temporary and would often cool back to its baseline prices. However, in times of stagflation, the sustained inflated price of these commodities is felt by consumers. Often times central banks could only implement a reactionary policy instead of a preventive policy.

What causes Stagflation?

Stagflation is caused by economical contraction & uncontrollable inflation rates happening simultaneously. Economical contraction could be led by a debt crisis, a loss in confidence that slows demand. While inflation can be caused by cost pull or demand-pull. Generally, every recession we have seen so far is caused by a combination of financial negligence, political incompetency, and a few unforeseen circumstances. There are no two identical reasons for recession and inflation. Fortunately, there are still some indicators we can look out for! 

If you are an avid viewer of financial news channels, you may come across some of the indicators that economists used to predict stagflation.

  • Indicators that are used to measure high inflation include
    • M2 Money Supply
    • Price of gas and oil
    • Producer price index (PPI)
    • The headline and core CPI
  • Indicators that are used to measure economic down include 
    • Real GDP growth
    • Labor market(including labor force participation & unemployment rate, U3 rate)
    • Confidence Indexes
    • Bond Yield Curve
    • Real Income

Is Stagflation worst than recession?

Yes, stagflation is worst than a recession. In a normal recession, the erosion of purchasing power is very minimal. People can rely on savings to cover their daily expenses(If they are unemployed), and the central banks have more tools to aid the recovery of a contracting economy. However, during stagflation, there is a gross erosion of purchasing power. Stagflation also tends to last longer as policymakers are walking doing a balancing act of managing inflation and reviving the economy.

How to invest during the period of stagflation?

In these troubling times, investors should continue to DCA invest in the broad market index and REITs ETFs. If investors are looking to preserve wealth(purchasing power), Commodities such as gold & silver should be considered. Energy, utility companies, hospital REITs, Commodities & housing markets tend to fair better and possibly outperform the stock market.