Are we going to see Stagflation again?

Are we going to see Stagflation again?

The 1970’s were known for flared pants, safari suits, big hair, vinyl records, disco and stagflation.  As a child in the 70’s I can remember most of those things I’ve just listed, except stagflation.  But then again, all I really wanted to do was ride my bike faster than my mates, play test cricket for Australia and stay out of trouble at school.  The economy to me back then was the bit of pocket money I would get for a few jobs around home. 

It wasn’t until I studied a bit of economics at Uni that I learned about stagflation.  And yet in recent months, there has been some speculation that the global economy may yet again experience this phenomenon.   Many clients have queried this too.

Fears that the global economy is about to experience a sustained period of high inflation alongside economic stagnation – or stagflation – as seen in the 1970s are probably unfounded.   Better central bank understanding of the risk, lower economic sensitivity to energy price rises, supply-side reforms, and low long-term inflation expectations, make today quite different from the 1970s.  

What is stagflation? 

Stagflation is an extended period of very slow economic growth when inflation remains stubbornly high.  It was first coined by British politician Iain Macleod in 1965 and was widely used during the 1970s oil crises. This brought about a long recession with high unemployment and double-digit inflation. 

What causes stagflation? 

Stagflation often follows a sudden reduction in productive capacity, coming just after an unexpected, but sustained, increase in input costs.  During the 1973 oil crisis the Organisation of Petroleum Exporting Countries (OPEC) imposed an oil embargo on the West.  The oil price quadrupled, leading to higher energy, transport and manufacturing costs. Inflation remained high for some time, even though unemployment jumped. 

Parallels are drawn with the recent COVID lockdowns. This interrupted the supply of microchips and other key components, leading to a spike in prices of finished goods, bringing wider cost pressures.  The current supply and demand mismatch has brought the highest inflation we have seen for 40 years. Some economists fear higher interest rates will reduce capacity without bringing inflation down, heralding a return to stagflation. 

So, are we headed for stagflation? 

A 1970’s-style period of high inflation with low growth is unlikely. This is due to some key differences between now and then: 

  • Central banks now better understand stagflation and the importance of keeping inflation and inflation–expectations low;
  • Developed economies are much less dependent on energy than they were in the 1970s;
  • Supply–side reforms introduced during the 1980s made the economy much more flexible and able to absorb supply shocks caused by higher input costs; and
  • Inflation expectations are now much lower than in the 1970s, following years of low and stable price rises. Despite US September CPI inflation of 8.2%, long-term consumer inflation expectations were just 2.9%. 

What does this mean for equity investors? 

A return to 70’s style stagflation is unlikely; sustained higher interest rates will bring down inflation by reducing demand and slowing the economy. Hence, investment markets are expected to remain volatile for some time.  Falling inflation should soon help stabilise interest rate expectations, giving businesses and consumers the confidence to make long-term plans.  

So stagflation is unlikely.  Even better, flares, safari suits and disco are also unlikely to make a comeback anytime soon.  I might just have to go and find my old dragster instead!!

Author
Director | Certified Financial Planner ® | Grad Dip FP

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