What is Stagflation?

“Hey Finshots, can you talk about Stagflation?”

“Finshots, you should write about stagflation”

“OMG!!! Why haven’t you written about stagflation yet? Everybody is talking about it.”

Alright. We’ve heard you. We will finally talk about Stagflation today.  :)

The Story

“For the engine which drives enterprise is not thrift, but profit.” — John Maynard Keynes

The year is 1931. The US economy is in crisis. Unemployment is on the rise. Investing for the future is an afterthought. And the government doesn’t have a clue on how to battle deflation. Yes — deflation. Unlike inflation, where you’re constantly worrying about price increases each day; with deflation, you’re looking at a broad-based decline in prices. You don’t know what’s happening around you. This stuff is unprecedented you think. The only problem is it’s not. See, most economists at the time believed this was the natural order of things. When the economy isn’t buzzing with activity anymore, people get fired and they tend to focus on saving money as opposed to spending it. And as demand for goods and services plateau, prices tend to decline in tandem. Also, businesses won’t have any real incentives to produce anymore. After all, if prices keep tanking each day, its fair to assume their margins aren’t plush. So they’re constantly thinking about downsizing, in effect, contributing to unemployment woes. And so, the cycle continues.

Thankfully, governments finally figured out how to reverse this cycle. They tried to kickstart growth by spending ludicrous amounts of money — on construction, on infrastructure, on creating new employment opportunities. They spent money they didn’t have. They borrowed from central banks who made billions of dollars accessible to these entities in the hope they could shock the economy back into action. And it worked. Once the government started pouring money into the real economy. Private corporates got in on the act as well. It seemed as if we had finally found the answer. But then during the 1970s, something strange happened.

Classical economists were puzzled to see a disturbing trend emerge in the US.
1. They were seeing a decline in general economic activity
2. They were seeing unemployment levels rise
3. However, they were also seeing prices increase each day

And this was weird. Think about it. How can prices increase when people are unemployed and hardly thinking about splurging on stuff? It didn’t make any sense. However, economists weren’t going to give up. They believed you could explain this phenomenon by looking at oil. At the time, oil-producing nations had imposed an embargo on the United States. They refused to ship oil. And as supply dwindled, prices started shooting up rather quickly. This pushed costs across the board as producing energy was now rather expensive. And with production costs rising, retail prices had to inch up. Anyway, this prognosis was hotly debated but economists did concede that this was a unique case in every respect and coined a new term to explain the phenomenon — Stagflation*.

Since then, economists have been devising policy prescriptions to tackle this problem with little success. So if anybody flags stagflation concerns in your own backyard, there’s very good reason to be concerned. In fact, that’s precisely what happened last year when former Prime Minister Dr. Manmohan Singh warned the government that India might be heading down this dangerous rabbit hole. Then, a few months later, RBI’s household survey pointed to the same inevitable conclusion. People were expecting prices to rise. They were telling surveyors they were being laid off. And everybody knew the economy was at a standstill.

So does this mean we should really be concerned about stagflation? Is it going to be that bad?

Well… We don’t know. But here’s the thing. We are seeing prices rise because of the lockdown and the ensuing supply disruptions pushed production costs way higher than anybody expected. So it’s natural to see a sudden spurt in inflation figures. But as these disruptions become less commonplace, we should ideally see costs normalize and if that happens, prices may start moderating as well. Yes, we still have to worry about job losses and GDP. But hey, battling inflation while you grapple with these two massive issues is a nightmare. So hopefully, it doesn’t come to that.

Until next time…

*The term was originally coined in 1965 by a British Politician. However it entered popular discourse during the 70s when economists started adopting the word to explain what was happening in the US. A technicality that we think you should be aware of.

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