Stagflation | What it is and why is it coming up so often nowadays?

I have been hearing a lot of this word, “Stagflation” and I do not understand fully the meaning of it although I know that it stems from stagnant and inflation. As I go on this journey to understand more, I know that it is not a positive environment to be in and I hope for the years to come, it doesn’t happen. So let’s dive right into it.

Firstly, stagflation is characterised by slow economic growth and relatively high unemployment—or economic stagnation—which is at the same time accompanied by rising prices (i.e. inflation). It refers to an economy that is experiencing a simultaneous increase in inflation and stagnation of economic output.- Investopedia.com

How it came about?

“Stagflation” came about during a period of economic stress in UK and politician Iain Macleod talked about inflation on one end but stagnation at the same time. It was then used again in the 1970s during the recession following the oil crisis. Economist have some theories on how stagflation can happen or existing theories on how to explains it.

• Oil Prices

One theory states that stagflation is caused when a sudden increase in the cost of oil reduces an economy's productive capacity. This was seen in October 1973 when OPEC issued an embargo against Western countries which caused a global rise in oil prices which we do also see due to the Russian-Ukraine War. As such, transportation of goods increases causing prices to raise causing inflation.

• Poor Economic Policies

Poor economic policies can cause inflation to soar even higher or cause the situation to go towards stagflation. It is difficult to explain this as it can be subjective and it is a theory that economist use to explain how stagflation comes about.

• The Gold Standard/The Oil Standard

Many are aware that the US dollar went off the gold standard in 1971 when Nixon announced cutting off links between the dollar and gold as part of a broad economic plan. This removed commodity backing for the US currency and put the US dollar and most other world currencies on a fiat basis ever since. Although “Petrodollars” came up in 1971 where foreign oil exporters have to use the US dollar for the medium of exchange making it established itself as a global currency. As the US dollar became pegged to a commodity that the world requires.

Japan’s “Lost Decade”

Many know about Japan’s lost decade where from 1991 to 2001, Japan experienced a period of economic stagnation and price deflation. Japan eventually managed to outgrow it but lost out a lot in growth when compared to other industrialised nations. Japan was actually flourishing before the 1990s but the real estate and equity markets burst in 1989 causing huge drops in stock prices as well as land prices which are still evident today on land that are not in the city areas.

The Central Bank of Japan, Bank of Japan, was by and large recognised for some mistakes made for example,

Monetary policy was stop-and-go; concerned about rising prices called inflation and soaring asset prices. The Bank of Japan put the brakes on the money supply in the late 1980s, which may have contributed to the bursting of the equity bubble. As equity values fell, the BoJ continued to raise interest rates because it remained concerned with still-appreciating real estate values. Higher interest rates contributed to the end of rising land prices, but they also pushed the overall economy into a downward spiral. In 1991, as equity and land prices fell, the Bank of Japan dramatically reversed course and cut interest rates. But it was too late, a liquidity trap had already been set, and a credit crunch was setting in. - Taken from Investopedia

I came across this article by TODAY titled,”For one Japanese salaryman, nearly a decade of US$4 annual pay rises” and I found it to be really demoralising especially for someone who has a family to take care of. A rough summary: Masamitsu (50 years old), a Japanese accountant, rarely goes to the cinema or travel the world and also rarely eats out as his annual salary of about US$34,000 which has an increment of US$4 every year is used to support his family of 3. His salary of US$34,000 is inclusive of a bonus of two months' pay twice a year and allowances. His wife works part-time to supplement their income.

He knows he can command a higher remuneration but accepts the current status from the many statements he mentioned as he sees the situation in Japan and knows that he is better off than most:

"Given my age, the base pay actually wasn't too bad, there were other places that were lower,”

"It's kind of unfortunate it doesn't rise more, even though I'm working hard,”

"I'd have liked to have had another child, but the one has taken everything we have,”

Fighting Stagflation

As mentioned earlier, stagflation is a combination of relatively high unemployment, inflation and slow growth. Some people are saying that right now, a recession is impending, however the government reacts differently to a recession and inflation which are both opposite of each other. There are definitely no easy way to fight stagflation but I have done some research.

• Monetary policy can generally try to reduce inflation with higher interest rates or increase economic growth by cutting interest rates. Monetary policy cannot solve both inflation and recession at the same time. We can see this at the recent FOMC meeting that the US Fed is very focused on tackling inflation as the effect of inflation is affecting majority of the US citizens especially those in the working class. I read on Twitter (not verified source) that the Fed will be more aggressive in tackling inflation as numbers show that there are available jobs for the unemployed and that by increasing the interest rate, they want to encourage people to take up the available jobs.

  1/11
  
  The story of this hiking cycle continues to be the utter disbelief that the Fed will get very aggressive, and even risk a recession.
  
  Yes, they will!
  
  And their policy is creating carnage in the bond market and eventually losses in your portfolio.
  
  A 🧵to explain

  — Jim Bianco biancoresearch.eth (@biancoresearch) April 7, 2022

• Next, one solution to make the economy less vulnerable to stagflation is to reduce the economies dependency on oil. Rising oil prices are the major cause of stagflation. I think this is something that might not be easy to control considering the war and pandemic which worsen supply chain issues.

I am not very knowledgable on this topic and am learning a lot as I research and write this out. Do let me know if there are any feedback. The situation is very uncertain and we can just see it from the stock and crypto markets. In March, my portfolio hit an ATH and entering April, it has dropped back quite significantly. 2022 will be a rocky year and we shall see how it all pans out. Pretty lazy to do a video up and anyway it will be the same content as my article. See you guys next week!

References: https://www.todayonline.com/world/one-japanese-salaryman-nearly-decade-us4-annual-pay-rises-1847766
https://www.economicshelp.org/blog/glossary/stagflation/
https://www.investopedia.com/ask/answers/040615/what-actions-or-policies-can-government-agency-take-counteract-and-end-stagflation-economy.asp
https://www.investopedia.com/terms/s/stagflation.asp
https://twitter.com/biancoresearch/status/1512106368647536649

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