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Effects of Stagflation

Updated on May 30, 2013

FOR MORE INFORMATION ABOUT THE EFFECTS OF INFLATION, PLEASE CLICK HERE (OPENS IN A NEW WINDOW)

FOR MORE INFORMATION ABOUT THE CAUSES AND EFFECTS OF DEFLATION, PLEASE CLICK HERE (OPENS IN A NEW WINDOW)

Before I describe the effect of stagflation, first we must understand what stagflation is. By definition during a stagflation, there is neither inflation, nor deflation. In terms of numbers or percentages, a stagflation occurs when the core consumer basket prices change between -0.5 percent and +0.5 percent for an extended period of time. Extended period of time is at least one year.

Core consumer basket is a selection of the basic goods and services that are necessities, and everyone in the economy needs them, such as bread, and utilities.

Now that we are clear with what stagflation is, lets examine its effects. In terms of effects when we compare stagflation to deflation and high inflation, the effects of stagflation resemble that of deflation more so then of inflation. As in the event of stagflation consumer prices not necessarily always decrease, the effects are also somewhat less severe than the effects of deflation. In fact stagflation also has some major positive effects, whereas deflation only has a few (high inflation on the short term is also beneficial due to lower export prices, and higher government revenues, but only on the short term).

In stagflationary environment financial-, and business planning is easier then during an extended period of depression. This is true at all three major players of the economy; residents, businesses, and governments. A more planable future also gives an advantage for businesses wanting to expand abroad (companies that already have considerable foreign operations won’t be as much affected by the stagflation in the particular country).

After a few years of stagflation, companies cannot increase their efficiency. In such a case those companies with considerable current assets (short term savings) or a  very good credit scoring with banks will start to acquire other companies in their own sectors. As more and more mergers and acquisitions go through, more and more sectors will become oligopolies (monopolies aren’t likely to form due to anti-monopoly regulations). These merged companies can then take advantage of synergies and cut production costs. As in most cases companies prefer to increase profits not market share, so they are likely to increase their prices. (low supply vs. high demand) so instead of spiraling into a deflation (which is also a possibility, although less likely), due to higher prices inflation starts to go up, ending stagflation.

Governments during stagflation maintain their regular revenues and expenses. However, to jumpstart the economy, they spend more on infrastructural projects and on corporate aids and subsidies. This is  needed as in a stagflationary environment the economy is also stagnating, that it changes around 0 percent (between -0.5 and +0.5 percent).

Positive Effects of Stagflation

The greatest advantage of stagflation lies in the stability of the real value of the domestic currency. Savings and investments in a stagflationary environment increase. Also, since inflation is low, the nominal value of investment interest are lower, but in terms of real value, these investment interests are similar to those in inflationary environments.

The installments of loans (most notably of mortgage loans) and credits are also easier to meet, as inflation does not devalue the wages and earnings of loan and credit holders. This results in less default loans and credit, which in turn increases the profits of credit institutions.

Conclusion

Stagflation has many direct and indirect effects. In some ways it is similar to inflation, but even more so to deflation, however there are also many very distinct differences.

Negative effects of Stagflation

As during stagflation consumer prices stagnate (hence the name “stagflation”) companies cannot raise their prices. In contrast to a deflationary economy, such companies profits do not shrink, or only by a minimal percentage. These somewhat lower profits can be compensated by improving the cost effectiveness of the company, which doesn’t necessarily mean firing employees.

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