Anyone who can remember the 1970s may recall stagflation and shudder. Now, headline writers are hinting that its toxic combination of weak growth and high inflation is due to return, bringing misery in its wake.
At Continuum we are looking at what stagflation is, what it could mean for your finances – and whether it is really coming at all.
What causes stagflation?
When the global economy ground to a halt after Covid, central banks around the world took action. They used low interest rates and quantitative easing, the process of creating new money to boost economic activity to provide an economic reboot.
The problem is that if they are mishandled, these economic tools also stimulate inflation, followed by something even worse – stagflation.
Stagflation is a combination of price inflation and a failure of the economy to grow. This means increasing unemployment and rocketing costs pushing the economy into a downward spiral. Savings fall in value, investments underperform and prices rise.
The term “stagflation” was first used in the 1960s by Conservative politician Iain Macleod. It occurs when money supply is expanding while the economy itself is constrained. When a government prints currency to increase the money supply at a time when the economy cannot grow, or if a factor such as a big tax increase slows economic growth, stagflation could result.
Classic economic theory viewed stagflation as impossible, but actual events have proved that economic theorists do not know as much as they pretend. In the 1970s stagflation was triggered by sharply rising oil prices, which destabilised the global economy.
There are concerns that the Covid aftermath could have a similar effect. If stagflation were to take hold, it would mean a return to recession – with a rather unpleasant twist. With interest rates already at rock bottom, there might be no obvious route out. The value of savings would be eroded, investments might produce poor returns and the outlook might be dire.
Is it actually happening?
In the US, recent reports might suggest conditions are ripe for stagflation. The latest jobs figures were discouraging, inflation is running high, while productivity growth may have stalled.
But what about the UK?
The recovery may have lost some of the impetus of a few months ago. According to the Office for National Statistics average weekly earnings grew by as much as 8.8% in April-June, while in July gross domestic product (GDP) grew by just 0.1% compared to 1% in the month before.
But although headline writers are enjoying prophesying doom and selling newspapers, stagflation may not be around the corner at all.
Rather than a structural failure of the economy, any setback in recovery for the UK is likely to be due to two purely temporary factors. The first being renewed concern about Covid and the ‘pingdemic’ that threatened to bring business to a halt again, the second a shortage of lorry drivers which means supplies could not reach factories and finished goods could not leave them. Remedies for both may already be in hand.
So what will happen?
Setbacks should be expected on the road to recovery, but although the economy is not growing as fast as we might want, it is certainly not stagnating, and there is no reason to think that it will.
But it still makes sense to prepare for inflation, which in July was running at 2.1%.
If your income is fixed, because you live on a pension annuity for example, inflation means that the retirement income that seemed generous when you stopped work can feel much smaller twenty years later. You receive the same amount each month, but it buys less. Year on year, a 2% inflation rate mounts up, meaning prices in 2021 are nearly 50% higher than in 2000. That winter coat that cost £100 in 2000 costs around £150 in 2021.
But if inflation erodes the value of cash and cash savings, it can support the rise in value of investments. Using your cash to invest, and so buy something which should hopefully increase in value can avoid the inflation problems.
Stagflation may not be coming, but inflation is. The good news is that at Continuum we can help you find ways to work with inflation to make the most of your wealth, rather than see it whittled away.
The information contained in this article is based on the opinion of Continuum and does not constitute financial advice or a recommendation to suitable investment strategy, you should seek independent financial advice before embarking on any course of action.
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