Inflation vs. Stagflation: How Do They Differ?

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 credit card holders.
• 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 US, 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 raises interest rates, which generally translates to higher rates on mortgages and variable rate debt, such as 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 and investment by businesses to use cash 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, high employment, and slow to no economic growth.

• Causes of stagflation: Rising inflation present during stagflation often accompanies 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, employees risk losing their jobs and lower wages, which can erode consumer confidence. Businesses may suffer from higher input prices and lower sales, which may also reduce profit margins and stock prices, which also impacts 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, 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.
• 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. May be accompanied by rising interest rates and reduction in purchasing power.
• Deflation: Opposite of inflation, deflation is the general decline in the cost of goods and services over time, 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 slowing economy is combined with an inflationary environment. 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

Stagflation may occur in an environment of high inflation, rising interest rates, higher unemployment, and slow to no economic growth. In this environment, the purchasing power of money is reduced and corporate earnings may be decreasing, which may also lead to lower stock prices.