In recent weeks, the war in Ukraine has significantly affected global markets. This is largely due to the considerable amount of uncertainty it has caused, as well as the strict sanctions on Russian goods, such as oil and natural gas.
This disruption has caused two main problems. The first is that the rising cost of food and fuel is contributing to an increase in inflation. The second is that the higher costs of raw materials may reduce the profits of manufacturers, which can hamper economic growth.
This has made some economists concerned about the prospect of “stagflation” rearing its head once again. Read on to find out what this phenomenon is and what it could mean for you.
Stagflation involves both economic stagnation and high levels of inflation
While it’s easy to be put off by the jargon, stagflation isn’t as complicated as you might think. The clue is in the name: it’s a combination of simultaneous economic stagnation and high levels of inflation.
While this might sound like an unlikely scenario, the UK has actually struggled with this problem before, in the 1970s.
During this decade, a shortage of oil pushed up the price of many other goods, as suppliers had to factor in increased transport costs. This coincided with an economic downturn and caused a long-lasting period of stagflation.
According to figures from the Office for National Statistics (ONS), the UK’s GDP fell by 1.5% in 1975 while at the same time, the Consumer Price Index (CPI) rose to an incredible 22.6%.
The rise in inflation, coupled with the UK’s struggling economy and high unemployment, led to a prolonged recession.
There are several explanations for why stagflation occurs
The phenomenon of stagflation is a curious one as, according to most economic schools of thought, inflation and unemployment are inversely related. Essentially, as one falls then the other should rise.
For example, if an economy is struggling then unemployment may increase, which would lead to a drop in consumer spending. Since supply would then outstrip demand, retailers would be forced to lower their prices. As a result, inflation should fall as the cost of living is now cheaper.
Of course, economics isn’t an exact science and so things rarely work so simply in practice as they do in theory!
There are several explanations for why stagflation can happen, which include:
A rise in the price of fuel
The first explanation for what causes this phenomenon is a sudden increase in the price of fuel. This has a knock-on effect for the cost of other goods, since it is now more expensive to transport them.
This could be a factor now as, in recent weeks, the cost of fuel has spiked due to the West’s economic sanctions on Russia, who export a significant amount of oil. According to the Guardian, petrol prices are 24% higher than they were in March 2021.
Having too much money in the economy
Another explanation for stagflation is that it occurs when the supply of money in an economy increases much faster than the supply of goods. This causes the value of those goods to increase significantly, pushing up the cost of living and so increasing inflation.
In recent months, the Bank have used quantitative easing to support the Treasury throughout the pandemic. According to government figures, this has involved the introduction of around £875 billion into the economy.
Poor economic management by the government
The third accepted explanation is that stagflation is the result of the government mismanaging the economy, which means there is some overlap with the second theory. Economists who subscribe
to this belief argue that over-regulation and restriction of markets can cause these issues to occur.
For example, if the government rapidly increased the supply of money in the economy while raising taxes, this could lead to stagflation.
Prolonged inflation could significantly reduce the real value of your wealth
One of the biggest problems posed by stagflation is that it has the potential to be a self-perpetuating cycle of economic recession and prolonged inflation. If this lasts for a significant period of time, it could affect your progress towards your financial goals.
This is because, as we discussed elsewhere, inflation erodes the real value of your money, and this can pose a problem for your long-term plans.
If you’re concerned about how it could affect you, please contact us, as we can help you to make informed decisions and minimise the impact that it has on your wealth.
No matter what the future has in store, we hope that as our client we can give you a greater sense of confidence that you have the right plan in place and you’re on track to meet your financial goals.
Get in touch
If you’re concerned about the prospect of stagflation and want to know more about what you can do to protect your wealth, please email us at firstname.lastname@example.org or call us on 0208 882 2979.
The value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.
This article is for information only. Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.