Inflation Vs. Stagflation

Updated: Aug. 10, 2022By: Kent Thune

You've heard about inflation, or the rise in the prices of goods and services over time. But what is stagflation and what should investors know about it? See our comparison and key differences of inflation vs stagflation, as well as deflation, disinflation, and hyperinflation.

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Differences Between Inflation and Stagflation

The differences between inflation and stagflation are subtle but important. Inflation is the general increase in the prices of goods and services in an economy over time. Low and steady inflation has historically been associated with low unemployment, healthy interest rates, and a mixed environment for investment securities.

Stagflation is a period of high inflation, high unemployment, and a stagnant economy. The investing environment during stagflation has historically been negative, as higher input prices combined with lower sales generally translate to lower earnings per share for corporations.

Inflation Basics

There's more to inflation than just a rise in prices of goods and services. To understand the basics of inflation, it's also important to know some of its causes, who it impacts, and how long it lasts.

  • Causes of inflation: The general cause of inflation is the demand for goods and services exceeds the supply. Inflation also will occur when money supply grows faster than GDP. Recent causes have been a combination of supply chain disruptions and higher consumer demand following the Covid-19 pandemic. An oil price spike following the 2022 Russian invasion of Ukraine compounded already high inflation.
  • Who inflation impacts: Those most negatively impacted by inflation are individuals like retirees who live on a fixed income, investors holding long-term bonds, variable-rate mortgage holders, and individuals with lines of credit balances. Additionally, equity markets tend to get jittery when inflation rises, putting equity investors at risk.
  • How long inflation lasts: Inflation, to some degree, is almost an ever-present phenomenon in most global economies. As for more extreme environments in the U.S., The Great Inflation lasted from 1965 to 1982.

2 Types of Inflation: Demand-Pull and Cost-Push

The two main types of inflation are:

  • Demand-pull inflation: occurs when the aggregate demand for goods or services increases but the supply remains the same, which results in prices being "pulled up."
  • Cost-push inflation: occurs when there is an increase in production costs and the producing companies respond with an increase in the prices they charge to consumers, thereby "pushing" prices up.

Risks of Inflation

The risks, or the potential negative effects, of inflation are:

  • Erosion of purchasing power: Inflation causes a decrease in the real value of money over time, meaning that it increasingly costs more to buy the same product or service.
  • Higher interest rates: To fight inflation, the Federal Reserve usually raises interest rates, which generally translates to higher rates on mortgages and variable rate debt, such as lines of credit and credit cards.
  • Falling bond prices: Interest rates and bond prices generally have an inverse relationship, meaning that prices for existing bonds fall as rates rise.
  • More inflation: If not contained, inflation can lead to more spending by consumers and more investment by businesses who want to transfer their cash to real capital now, rather than wait for higher prices later.

Stagflation Basics

Stagflation is a term that describes the simultaneous occurrence of stagnation and inflation in an economy. Conditions typically present in an economy experiencing stagflation include rising prices for goods and services, rising interest rates, relatively high unemployment, and slow to no economic growth.

  • Causes of stagflation: Rising inflation is often accompanied by more aggressive monetary policy from the Federal Reserve (rising interest rates), which tends to slow, or "stagnate," the economy.
  • Who stagflation impacts: During periods of stagflation, there's increased risk of employees losing their jobs, as well as lower wages, which can erode consumer confidence. Businesses may suffer from higher input prices and lower sales, which may also reduce profit margins and drive stock prices lower, impacting investors.
  • How long stagflation lasts: The length of stagflation is more commonly measured by a matter of months (one or two quarters) rather than years. In an extreme example, stagflation was present in multiple economies from 1973 to 1982.

2 Main Causes of Stagflation

The two main causes of stagflation are:

  • Supply shocks
  • Fiscal and monetary policies

For example, low supply of commodities or products, combined with a Fed policy of rising rates, can produce inflation and a slowing economy simultaneously, which are classic signs of stagflation.

Risks of Stagflation

The risks, or the potential negative effects, of inflation are:

  • Erosion of purchasing power: The presence of inflation during stagflation reduces the real value of money arising from the higher cost of goods and services.
  • Rising interest rates: Since the Federal Reserve is typically fighting inflation during periods of stagflation, they do so with higher rates. Higher rates can negatively impact consumers with debt balances, further pressuring the economy.
  • Lower corporate earnings: The combination of higher input prices and lower sales reduces corporate earnings, which can also hurt stock prices.
  • Higher unemployment: To protect the earnings bottom line, businesses may reduce labor costs by laying off employees.

Deflation vs. Disinflation vs. Hyperinflation

There are multiple "flations" in economic terminology, including inflation, deflation, disinflation, stagflation, and hyperinflation.

  • Inflation: The general rise in the cost of goods and services over time. Inflation reduces purchasing power. It may be accompanied by rising interest rates if central banks want to slow down the economy.
  • Deflation: Opposite of inflation, deflation is the general decline in the cost of goods and services over time, usually caused by reduction in money supply or credit availability.
  • Disinflation: Not to be confused with deflation, disinflation is a decrease in the rate of inflation, where inflation increases at a slower rate.
  • Stagflation: Occurs when a stagnant economy is combined with an inflationary environment. Stagflation is typically accompanied by rising costs of goods and services, rising interest rates, and higher unemployment.
  • Hyperinflation: An extreme environment of inflation, hyperinflation may be accompanied by soaring prices for goods and services and excessive devaluation of currency.

Bottom Line

Inflation is the general increase in the prices of goods and services in an economy over time, while Stagflation is a combination of high inflation and simultaneous slow growth. While inflation, at least at low and stable levels, is accepted as normal and healthy, stagflation is universally seen as a worrisome problem that is difficult to remedy.

This article was written by

Kent Thune profile picture
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Kent Thune, CFP®, is a fiduciary investment advisor specializing in tactical asset allocation and portfolio management with a focus on ETFs and sector investing. Mr. Thune has 25 years of wealth management experience and has navigated clients through four bear markets and some of the most challenging economic environments in history. As a writer, Kent's articles have been seen on multiple investing and finance websites, including Seeking Alpha, Kiplinger, MarketWatch, The Motley Fool, Yahoo Finance, and The Balance. Mr. Thune's registered investment advisory firm is headquartered in Hilton Head Island, SC where he serves clients all around the United States. When not writing or advising clients, Kent spends time with his wife and two sons, plays guitar, or works on his philosophy book that he plans to publish later in 2022.

Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

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