Stagflation vs. Inflation: What's The Difference?

Understanding the difference between stagflation vs. inflation is crucial.

These two economic phenomena involve rising prices and can have a major impact on businesses and consumers. While these terms are often confused, they refer to two very different things. But, what is the difference between inflation vs. stagflation? What does it mean for you as a consumer? There are some critical differences between the two that we will address in this article.

Inflation

Inflation is an increase in an economy's overall price of goods and services. At low, steady rates, inflation can produce low unemployment rates and healthy interest rates. There are two main types of inflation to consider:

1. Demand-pull inflation. Demand rises, but supply stays the same
2. Cost-push inflation. Production costs rise, increasing product costs which leads to higher prices.

Historically, inflation is ever-present. This means that it is constantly happening, no matter the economic climate. Although, inflation is higher or lower depending on economic and social factors. An example of a time of high inflation is "The Great Inflation," which lasted from 1965 to 1982. To recover from inflation, a country has to get to the root of the problem. If inflation is developing due to high demand, the government may need to:

• increase taxes
• cut spending
• put in place exchange rate policies

Central banks use a variety of tools to try to keep inflation under control. For example, interest rates and monetary policy. If inflation is developing due to high production costs, the government may need to:

• put in place price controls
• practice monetarism

#CaminoTip Hedging against inflation can help keep your money safe and valuable.

Causes and effects

There are two leading causes of inflation:

1. Consumer demand exceeds supply
2. The money supply grows faster than the country's gross domestic product (GDP)

Inflation can have both positive and negative effects on an economy. Inflation can cause the prices of goods and services to increase. This can lead to a decrease in purchasing power. It can also lead to higher interest rates, impacting both businesses and consumers. Finally, inflation can also result in lower wages for workers as companies attempt to offset rising prices.

#DidYouKnow Inflation can encourage spending and investment. Why? People expect prices to continue to rise in the future.

Inflation impacts businesses and individuals. Some of those who experience the most loss are those who:

• have credit cards (especially with variable interest rates)
• live on a fixed income
• hold long-term bonds
• have a variable-rate mortgage

Stagflation

Stagflation occurs when high inflation combines with stagnant economic growth. Hence, the combined term of stagflation (stagnation+inflation). #DidYouKnow Stagflation is a specific situation that can occur during times of inflation. Historically, stagflation lasts months at a time rather than years at a time. However, the COVID-19 pandemic has changed how stagflation behaves. More recently, the United States has experienced a prolonged state of stagflation. It has only become worse with the war on Ukraine and other social issues. #DidYouKnow In 2021, the United States experienced an inflation rate of 4.7%. Due to unemployment rates and a slowing economy, many people called it a stagflation. There are a few solutions government has to fight stagflation:

1. Adjust monetary policy. Either to reduce inflation by inducing higher interest rates or to increase economic growth by lowering interest rates.
2. Reduce the country's dependency on oil. Rising oil prices are contributing to increasing stagflation).
3. Increase productivity.

It's important to note that we cannot treat inflations and recessions at the same time. So if a country is going to respond to stagflation, it needs to determine what the most important goals are.

Causes and effects

Economic stagnation may occur along with any of the following:

• Rising prices
• High unemployment rates
• Increasing interest rates
• Slow or negative economic growth

Stagflation often happens when the government attempts a more aggressive monetary and fiscal policy during times of inflation. This leads to rising interest rates, which slows the economy. Stagflation can also occur if there are supply shocks (when there is a low supply of various products). Some of the main effects of stagflation are:

• A decrease in economic growth
• Higher unemployment rates
• An increase in inflation rates
• A reduction in purchasing power for consumers
• An increase in interest rates
• A decrease in business and investment activity.

The slow growth of the economy causes an increase in the unemployment rate, which decreases spending. During times of stagflation, both employees and employers suffer:

• Employees may lose their jobs
• Employees may incur lower wages
• Businesses may have higher production prices
• Companies may have fewer sales
• Investors may lose money they've put into businesses

Stagflation vs. Inflation: Key Differences

Here are the fundamental differences between inflation and stagflation. While prices may increase in both cases, they cause very different economic situations.

Other Types of Inflation

Along with inflation and stagflation, there are other types of inflation to consider.

Deflation

Deflation is the opposite of inflation. It refers to an economic state in which the price of goods and services decreases. This occurs when there is a decrease in the money supply. Deflation may lead to more savings, but it also decreases spending, which weakens the economy. This lasts for a few months at a time since inflation is more common and preferred. To recover from deflation, a country would need to increase government spending, cut tax rates, and lower bank reserve limits. These all encourage consumers to begin buying again.

Hyperinflation

Hyperinflation is an extreme state of high inflation. This causes very high prices and severe currency devaluation. There are two primary causes of hyperinflation:

1. An increase in the monetary supply that's not matched with economic growth
2. Demand-pull inflation

Hyperinflation can ruin an economy. Essential goods will become so expensive that consumers will begin hoarding them. Even those who are saving will lose money as cash loses its value. This economic state can last for years. Recovering from hyperinflation involves cutting government spending and altering the current basis.

Reflation

Reflation denotes a period of economic recovery. This occurs when a country tries to increase economic stimulation while decreasing the unemployment rate to prevent or reverse deflation. In response, there may be stimulus payments, tax cuts, and interest rate reductions. Reflation stimulates the economy, leading to many changes:

• Increasing prices
• Increasing wages
• Decreasing unemployment rate
• Increasing gross domestic product

Reflation continues until the government reaches its goal inflation rate. This may take months or years, depending on the inflation rate before the introduction of reflation. Keep in mind that inflation is normal, so reaching this goal (as long as it's in control) can be positive for the economy.