The currently very high inflation rate is on everyone’s mind. In our blog article on inflation some time ago, we explained its importance. 

However, there is also talk of stagflation and its potentially disastrous effects on the economy. This article explains what stagflation is, why it could be so dangerous, and what it means for your finances.

What is stagflation?

Stagflation is “the worst of both worlds,” a combination of inflation and stagnation. Inflation means everything becomes more expensive. Stagnation means economic activity comes to a standstill. 

Stagflation, then, is when inflation is accompanied by slower economic growth and high unemployment. 

Typically, these economic conditions do not occur together. This is because unemployment and inflation are usually inversely related. Thus, when unemployment increases, inflation usually decreases, and vice versa. However, the stagflation in the 1970s shows that this relationship is not as stable as once assumed. In connection with the Corona crisis, many now fear that stagflation could return.

Why would stagflation be bad?

The combination of slow growth coupled with high unemployment and high inflation puts the economy under considerable pressure. 

Stagflation means you can afford less because you earn less money (slow growth), but you have to spend more because everything becomes more expensive (inflation). Your expenditures and those of your fellow human beings are thus forced to slow down. As a result, business revenues are also decreasing (slow growth), making the overall effect on the economy even worse (unemployment, slow growth). As a result, wages have to be lowered, people are laid off (high unemployment), and we move deeper and deeper into a downward economic spiral. 

In addition, politicians and economists face a dilemma. If they decide to raise central bank interest rates to curb inflation, borrowing becomes more expensive, negatively impacting the economy. On the other hand, inflation rises if the central bank increases the money supply to stimulate the economy. 

What does history show? In the 1970s and 1980s, most major economies experienced periods of stagflation. This surprised economists because the prevailing economic theory at the time, Keynesian macroeconomic theory, assumed that simultaneous increases in inflation and unemployment were not possible. This assumption was based on the idea that a growing money supply (and the associated inflation) would increase employment and promote economic growth.

Will the pandemic lead to stagflation?

Experts disagree on whether the pandemic could cause stagflation. However, some experts talk of a significant risk of stagflation as the pandemic has caused inflation and unemployment to skyrocket in many countries while slowing economic activity through supply shortages and labor shortages. 

Others are less concerned about this and expect the economic situation to improve as the pandemic is gradually addressed. Moreover, they assume that central banks still have tools at their disposal to get a grip on the situation. As long as central banks set inflation targets so that people are not surprised (or, in complicated terms, inflation expectations do not rise), everything is fine. 

And what does all this mean for my investment decisions?

The threat of stagflation makes a well-thought-out investment strategy all the more important. If your portfolio is well-diversified, you’re on the safe side. High inflation rates imply that you should invest some of your money so that its value does not dwindle over time. 

One thing is sure: A solid, long-term financial plan is the best way to protect your finances from stagflation. But did you know that at UnitPlus, we also offer a personalized savings plan with amounts tailored to you?

Whether it’s inflation, stagnation, or stagflation, investing with UnitPlus will keep you safe during turbulent economic times.