As we continue to experience high levels of inflation not seen in decades, and with slowing economic growth, the theme of “stagflation” is once again in the spotlight. In June, the World Bank revised its 2022 global growth forecast downwards, warning that various global economies may be at risk of stagflation. As such, some investors have been asking: are we in for a period of stagflation here at home?
What is Stagflation?
The term stagflation comes from a combination of the words “stagnation” (a prolonged period of slow economic growth) and “inflation” (the general increase in the prices of goods and services in an economy), which largely emerged to describe the economic situation that resulted in the 1970s and early 1980s. Typically, inflation occurs during periods of strong economic growth and low unemployment, when increasing demand pushes up the prices of goods and services. However, the stagflation of the 1970s was a period in which inflation was high, but economies were slowing and unemployment was high, partly driven by commodity price shocks and economic policy errors.
In the 1970s, the price of oil skyrocketed due to a series of oil price shocks, as a result of the OPEC embargo in 1973 and the Iranian Revolution in 1979. There were also various fiscal and monetary policy errors. Inflation had already been increasing in the early 1970s from rising government spending. The central banks continued to maintain their accommodative monetary policies by keeping interest rates low and expanding the money supply, hoping that this would alleviate high unemployment levels. Instead, this helped to fuel the inflation problem. By the end of the decade, Paul Volcker took over as the chair of the U.S. Federal Reserve and allowed the Fed funds rate to rise over 20 percent in order to end high inflation, but this wasn’t until after almost a full decade of enduring inflation. This shock led to more severe economic consequences.
Some are comparing today’s situation to that of the 1970s because of the abrupt “price shocks” that we are experiencing with energy and other commodities. This has come on the heels of significant expansionary monetary and fiscal policy, reminiscent of the 1970s. With more rapid tightening of monetary policies by central banks, we are now facing the prospect of weakening growth.
Is Stagflation Imminent?
There is no denying that a significant portion of the world is living through a period of above-average inflation and slowing growth. Closer to home, much of the economic outlook depends on what will happen with inflation over the near term. If inflation shows signs of moderating, the central banks can take a less aggressive approach to raising interest rates, which will likely lessen the economic consequences. However, for now, there are worries that continued aggressive rate hikes have the potential to lead to a recession.
Here at home, there are differing views about the possibility of stagflation. In a recent media article, former Bank of Canada Governor Stephen Poloz suggested that the commodities price shock we are seeing today will lead to an economic slowdown and stagflation.1
However, others believe that today’s situation is much different from the 1970s. One reason is that the central banks have been taking credible action to try and temper inflation; similar actions were largely absent throughout the 1970s. As well, the increase in commodities prices isn’t quite near the level that was seen in the 1970s, when economies were much more dependent on oil. Unlike that period, both corporation and consumer balance sheets still remain at resilient levels.
Consider also that Canada’s economy may be better positioned than its peers to face the challenges of today. Our domestic energy production, as well as our access to a vast array of commodities, will continue to support economic output. In Europe, many countries are dependent on energy and other commodities imports, especially from Russia, which puts significant downward pressure on their economies. As well, in some markets, high unemployment is a concern: Spain and Greece have unemployment levels of around 13%.2
While increases in interest rates are expected to continue over the near term, a gradual approach to raising rates may not adversely impact our labour markets. Rates have been held at artificially low levels for many years and needed to be raised. For now, labour markets remain strong, with the latest statistics suggesting our unemployment rate has dropped to its lowest on record at 5.3%.3 In the early 1980s, unemployment averaged around 8%, while inflation reached as high as 12.5%.1
A Final Thought
Regardless of your perspective on stagflation, as advisors we feel that it is important for investors to remember that economies, like the markets, are cyclical in nature. Though it may not feel like it today, we will get through this challenging economic time. Periods of retrenchment have always been followed by new growth, economic expansion and, from an investing perspective, improved equity values. There is little reason to expect otherwise in this cycle.
2. April 2022 figures. https://www.destatis.de/Europa/EN/Topic/Population-Labour-Social-Issues/Labour-market/EULabourMarketCrisis.html
3. March 2022 figures. https://www.cbc.ca/news/business/jobs-march-canada-1.6413073