What is stagflation?

The world has seen this before too. During the 1970s recession. It’s a disturbing cocktail of relatively high unemployment, slow or stagnant economic growth and high inflation. 

A stagflationary period can also witness inflation combined with a decline in GDP.

The term was made popular in the 1970s when countries that were dependent on imports for crude oil needs faced a recession coupled with high inflation. 

Many developed countries experienced stagflation with high rates of unemployment as a result of an oil shock when the OPEC cartel imposed an embargo against Western countries in 1973.

The embargo contributed to an upward spiral in oil prices with global implications. The price of oil per barrel first doubled, then quadrupled, imposing skyrocketing costs on consumers and structural challenges to the stability of whole national economies.

Stagflation can be the result of a supply shock, like a rapid increase in the price of oil. Costlier oil makes production costlier and less profitable, slowing down economic growth while raising prices in the economy.

Another example of stagflation is when central banks print currency, which would create inflation as the money supply goes up while on the other hand, the government creates policies that harm the industry, which would constrain supply and slow economic growth.  

An expansion in money supply while supply is being constrained can result in stagflation.

Credit rating agency Fitch Ratings has said the prospects of prolonged inflation and slower economic growth are rising, with added supply-chain risk from sanctions on Russia, China’s pandemic lockdowns, and tighter labour market conditions in general. 

They expose 12 Indian corporations, which include 8 PSUs in the energy and utility sectors and four private sector firms, to “elevated” downgrade risks, according to Fitch Rating.

Under the stagflation scenario, Fitch assumes the surge in global oil prices lasts over a longer period with average annual prices of $150/bbl in 2022 and $130/bbl in 2023.

Though there is no definitive solution to stagflation, according to economists there has to be a rise in production to the level that it leads to high growth while inflation stays the same.

When the level is achieved, it would prompt the central bank to tighten its monetary policy to bring down inflation.