What is Stagflation?
Stagflation is a term used to describe an economy that is experiencing growing inflation rates while simultaneously enduring minimal economic growth. This was first characterized and defined when many developed economies experienced growing inflation and high unemployment in the 1970s from the oil crisis.
Why is it Important Now?
Currently, global economic growth is expected to decrease from 5.7% in 2021 to 2.9% for 2022. According to the World Bank this growth rate is also expected for both 2023 and 2024. A drastically lower global growth rate, the war in Ukraine, supply chain issues, lockdowns in China, and the risk of stagflation, are all affecting countries that are near recession.
What developed economies are experiencing now is different from the 1970s form of stagflation because unemployment is not incredibly high. In fact, Canada has a record low unemployment rate of 5.1% in Q2 2022. Therefore, the labour market is not the main issue with stagflation today. Stagflation today relies much more on trade restrictions, fiscal, monetary, climate, and debt policy changes.
As an investor in the public markets, the latest news has been regarding the Federal Reserve raising interest rates to dampen consumer demand to control inflation. Although it has the correct outcome in mind, the opposite could also occur through this monetary policy change. With low economic growth, you have low consumer demand already. With rising interest rates, you harm the possibility of making economic growth accessible and "cheap" to businesses and encourage consumer spending. Using interest rate hikes to control 2022 stagflation has the potential to stagnate the economy even more.
After the measures implemented by the Federal Reserve, the Bank of Canada now has the possibility to follow suit. The reason for this is that Canadian society expects the Bank of Canada to use the same interest rate hikes to control their own inflation worries. In both situations, securities issued by governments to fund expansions become less attractive. This in turn halts economic growth. This is because of the inverse return relationship of bonds and the potential increase in the supply of T-Bills from contractionary monetary policy actions.
Depending on the future of government policy, a period of stagflation could be experienced. With low global economic growth and geopolitical factors affecting world markets, it is unknown as to how much raising interest rates will change the inflation levels we are witnessing.
I encourage every reader to pay attention to the economics of the situation to help discern what is going on in the public markets and how to plan for future shocks.