• Stagflation is a combination of high inflation and economic stagnation manifested by a slow growth rate and rising unemployment in an economy.
• Inflation is the rate of increase in the prices of goods and services in an economy.
• While moderate inflation can boost GDP growth, stagflation has a purely negative impact on the economy and the country’s GDP.

Inflation is the decline in the purchasing power of money due to the general rise in the prices of goods and services in an economy. Stagflation is an economic phase where high unemployment, high inflation, and stagnant or sluggish growth rates coincide. While inflation at a moderate rate can boost economic activity and growth, stagflation has a purely negative impact on the economy.

In this article, we explore the stagflation vs. inflation debate in detail to help you understand the key differences between the two in terms of causes, impact, and recovery.

Inflation is defined as the broad rise in the prices of goods and services across the economy. Inflation occurs when the prices of goods and services rise over a sustained period, resulting in the loss of purchasing power. CPI, or the Consumer Price Index, is the most commonly used metric to measure inflation. CPI measures the average change in prices for a basket of goods and services over a year.

Demand-pull inflation occurs when the demand in the economy outpaces supply. Cost-push inflation happens due to the rise in the cost of production inputs like land, labour, and raw materials. Companies pass on this increased production cost to the end consumer, resulting in higher prices of goods and services. Expansion of monetary policies like low interest rates can boost the supply of money in the economy, resulting in increased investment and consumption expenses and exerting upward pressure on prices.

What is stagflation?

Stagflation is an economic condition characterised by a combination of a slowing economic growth rate, high inflation, and a high unemployment rate. The term was coined by Iain Macleod in the 1960s. During periods of stagflation, consumer spending slows down, resulting in lower demand. Despite falling demand, inflation remains high, resulting in a contraction of business activities. As a result, the growth rate of the economy turns low, zero, or negative. In other words, the term simply refers to a stagnating economy.

Tackling stagflation is generally difficult for economists and policymakers since trying to correct any one of the disorders worsens the others. For instance, if policy changes are implemented to tackle the slow growth rate, inflation rises. During the 1970s, the oil supply crisis caused stagflation in several countries around the world.

The stagflation vs. inflation comparison outlines the economic impacts of the two phenomena. Here’s a quick overview to help you understand how the economy reacts to stagflation vs. inflation:

• Overall economic growth: Stagflation stagnates economic growth, resulting in a low to negative growth rate. Inflation results in higher demand, boosting GDP growth. Therefore, moderate levels of inflation are considered favourable for the economy.
• Business investment: The sluggish growth rate during stagflation discourages business activities and fresh investments. However, moderate levels of inflation can help boost business investments as companies want to capitalise on rising demand.
• Unemployment: Stagnation is characterised by high levels of unemployment, while inflation has historically maintained an inverse relationship with unemployment. Moderate inflationary pressures mean expanding business activities and creating more jobs and employment opportunities in the market.
• Consumer spending: The high levels of unemployment and rising prices during stagflation result in declining rates of consumer spending. While inflation reduces the purchasing power of consumers, it does not necessarily curb spending, especially if wages rise.

While stagflation is rarer than inflation, paying attention to the inflationary trends can give you an idea if stagflation is around the corner. As an investor, you should know the differences between stagflation vs. inflation to make prudent financial investments and prepare ahead. Here’s how you can protect your wealth and navigate through periods of inflation and stagnation:

• Invest in inflation-protected securities: Remember that rising price levels are common for both inflation and stagnation. In other words, both threaten to lower the purchasing power of your wealth. Therefore, consider investing in assets that offer inflation-adjusted returns, like IIBs (inflation-indexed bonds), to protect the value of your investment.
• Look for value: When the economy slows down, consider a value investing approach to seek out undervalued stocks. Growth stocks may not be a prudent choice since the rising prices can erode the growth potential of such stocks. Moreover, stagflation can continue for longer periods than inflation.
• Turn to essential goods: Consider investing in essential goods like consumer staples or utilities. The demand for these goods remains more or less unchanged during inflation and stagflation, ensuring consistent returns for these sectors.  
• Diversify your investments: Diversification is the cornerstone of investing. By building a diversified portfolio of stocks, bonds, real estate, gold, and other commodities, you can balance risk and return.
• Invest in gold: Historically, gold has served as a potent hedge against inflation. The yellow metal acts as a store of value, appreciating under inflationary pressures.

Determining the causes of stagflation is an integral part of knowing the differences between stagnation vs. inflation. As such, there is no real consensus among economists when it comes to delineating the causes of stagflation. That said, the most commonly cited causes are listed below:

• Price shocks: Some economists believe that stagflation occurs due to price shocks. They cite the example of the 1970s oil crisis, where the sudden increase in oil and petroleum prices caused stagflation in several countries. In 1973, OPEC issued an embargo against Western countries, restricting the supply of oil to these countries, resulting in a rapid rise in oil prices around the world. This led to an increase in the cost of transportation and goods, along with rates of unemployment.
• Poor economic policies: Economists also point out that stagflation can be caused by the implementation of poor fiscal and economic policies. Poorly drafted economic policies that advocate for a harsh regulation of markets, goods, and labour under prevailing inflationary pressures can lead to stagflation. For instance, economists blame US President Nixon’s restrictive policies of import tariffs and wage and price freezing that froze prices for 90 days to avoid further rises. However, once the controls were relaxed, prices accelerated rapidly, spiralling out of control.

So, now you know the stagflation vs. inflation debate in detail, as well as their possible causes. To sum it up, inflation is a natural economic phenomenon of gradually rising prices, while stagflation is a rare occurrence of stagnated economic growth, high inflation, and high unemployment levels. The impact of stagnation can be much more pronounced and harmful to the economy.

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