March 17, 2025
8 mins read
Stagflation and inflation both involve rising prices, but they occur under different economic conditions. Growth is usually accompanied by inflation in certain economic phases, and stagflation is characterised by a slowing of the economic activities accompanied by high prices.
Let’s take a quick look at the causes of inflation:
As the name suggests, demand-pull simply means that the total demand for goods and services in the country is growing at a faster speed compared to the country‘s production capacity thus pushing inflation higher.
The increase in the price of manufacturing goods and services is the cost-push cause of inflation. Now, this can be either a rise in labour expenses or raw material expenses etc.
Another interesting cause of inflation is the built-in inflation. When there is a rise in the price of goods and services, the labour expects more salaries, and as their income increases, the price of goods and services in the market increases even further, creating a wage-price spiral.
To begin with, stagflation is any situation where the economy is facing inflation paired with deceleration in the economy and persistently high levels of unemployment. Two main components of stagflation are inflation and unemployment.
Simply put, when the economy is facing a slow or stagnant growth rate accompanied by higher unemployment and reduced wages it is said that the economy is going through a stagflation.
Here is a list of three major causes of stagflation:
The demand shock factor basically talks about a situation when the economy is facing a decrease in the demand for goods and services. In such a situation, the economy is meant to take a hit thus leading to a situation like stagflation.
In situations when there is a scarce or unreasonable price hike for essential commodities in the market, like oil it spurs supply-side factors. To deal with such a situation, businesses often resort to increasing the prices of these commodities, thus leaving the market in a supply-side shock eventually leading to stagflation.
In many cases there are monetary policies that look good on paper but do not work out equally well practically. This can lead to stagflation.
Now that you have a fundamental understanding of stagflation and inflation let’s take a quick look at this table highlighting the differences between these two situations:
Factor | Inflation | Stagflation |
Price Trend | Rising prices | Rising prices |
Economic Growth | Moderate to strong | Weak or stagnant |
Employment | Stable or improving | Rising unemployment |
Demand Conditions | High demand | Weak demand |
Policy Complexity | Manageable | Difficult to control |
Economic Environment | Expansionary | Slowdown with inflation |
Rise in prices lowers the buying capacity but, in most cases, contributes to the growth of business and provides employment. Increasing prices may be partly compensated by increasing earnings in times of economic momentum.
The stagflation undermines consumer confidence because of the increased prices and employment insecurity. The cost of doing business increases where the demand is not supported, and this has an impact on the profitability and investment activity.
Inflation enables central banks to apply conventional instruments. Stagflation constrains the effectiveness of the policy since restricting the inflation rate can slow down development even more.
Be aware of the inflation rates, employment rates, and growth numbers to know about the economic situation in general and how it affects income stability.
Stabilise revenues by diversifying from one economic driver in case of fluctuations in prices or in case of poor growth cycles.
Track cost structures and budgeting because the increase in prices will have different implications on household and business costs during inflation and stagflation conditions.
Give attention to financial planning that takes into consideration the price pressure, as well as the income uncertainty, particularly when the economy is experiencing a prolonged slowdown.
The main indicators of inflation are slower or stagnant economic growth, higher unemployment, and increased price rise or surging inflation.
Inflation is often marked as a situation where the price of goods and services in the market increases rapidly as compared to the country’s purchasing power. This simply means that inflation reduces the purchasing power of the country.
Yes, stagflation can occur in modern economies if inflation surges without any change in the economic growth of the country and a persistent increase in unemployment. However, stagflation is a rare phenomenon that has occurred only a handful of times in the world.
Dealing with stagflation is tricky since any step to curb one of the reasons for stagflation can trigger the other cause. However, it is advised that the government can adopt a mixture of both monetary and fiscal policies to combat stagflation. Additionally, the government can also encourage investors to put their money in assets in securities that are less likely to face supply-side shock.
During an inflationary period, investors need to adjust their portfolios accordingly. Some of the suggestions that can help them adjust a portfolio are to increase investment in inflation hedging- assets like commodities, real estate, TIPS, etc and review their fixed income holdings to reduce exposure to traditional bonds and also consider short-term bonds.
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Content Partner - Dalal Street Investment Journal Wealth Advisory Private Limited
This article is for educational purposes only and should not be considered investment advice. Market investments are subject to risks. DSIJ Wealth Advisory Private Limited is a SEBI-registered Research Analyst (Reg. No: INH000006396) and Investment Adviser (Reg. No: INA000001142). Please consult your financial adviser before investing.
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