- Inflation is defined as the increase in the overall level of prices for various products and services in a given economy over time.
- As a result, money loses value since it no longer buys as much as it used to, and a country’s currency’s purchasing power falls.
- Central banks aim for mild inflation of up to 3% to help boost economic growth, but inflation any higher than that could lead to extreme circumstances like hyperinflation or stagflation.
- Hyperinflation is defined as a period of rapidly growing inflation, whereas stagflation is defined as a period of rapidly rising inflation combined with slow economic development and high unemployment.
- Deflation occurs when prices fall sharply as a result of an excessively high money supply or a decrease in consumer spending; lower costs mean corporations earn less and may have to lay off workers.
Is there a distinction between stagflation and inflation?
Stagflation is a word coined by economists to describe an economy with high unemployment, inflation, and a slow or stagnant rate of economic growth. Stagflation is something that authorities all over the world aim to avoid at all costs. The population of a country are affected by high rates of inflation and unemployment amid stagflation. High unemployment rates exacerbate a country’s economic downturn, leading the economic growth rate to swing only a single percentage point above or below zero.
In basic terms, what is inflation and deflation?
Inflation is defined as an increase in the overall cost of goods and services in a given economy. Deflation, on the other hand, is defined as a general decrease in the price of goods and services, as measured by an inflation rate below zero percent.
In basic terms, what is stagflation?
- Stagflation is defined as a time of low economic growth, unemployment, and growing inflation.
- Google searches for the keyword “stagflation” have increased as oil and gas prices have reached new highs.
- Financial markets, according to expert Alberto Gallo, are trapped between fears of stagflation and optimism that the economy will pick up speed.
Is stagflation a precursor to deflation?
Retailers have made a combination of selected price hikes and unit reductions based on decreased consumption projections as of this writing and going into the second half of the year.
The theory goes that in a true inflationary environment, characterized by too many dollars chasing too few goods and spawned by the Fed unleashing billions of newly minted dollars, buying back treasury bills, and keeping the federal funds rate near zero, consumers would not only accept higher prices, but would also buy two of something instead of one, anticipating that prices would rise even further.
As a result, they’d demand higher pay, forcing businesses to hike prices once more.
Consumers and businesses would borrow more, forcing the government to raise interest rates, among other things.
The increasing inflationary spiral is this.
In today’s reality, the inflation theory isn’t valid.
Less than 50 cents of every dollar spent by the Fed (out of a total of $684 billion in new funds pushed into the banking system to jump-start lending and economic growth) ends up in the “real” economy.
The actual reality is that around 9% of the qualified workforce is still unemployed, with many facing foreclosure (as property prices continue to fall) and attempting to pay off debt while boosting their savings rate. Businesses have nearly $2 trillion in cash on hand because they don’t believe customer demand warrants expansion and growth (including hiring). As a result, this inflation will not reach anything resembling an upward spiral.
Instead, customers will pay for growing food, petrol, and other basic products and services with money from their clothing, entertainment, “dining out” budgets, or other discretionary sections of their wallet.
And, as a result of the selective price increases, the makers and sellers of all the non-essential items will end up putting those items on sale and taking a damage to their bottom lines. They will also buy fewer units in the future. Some merchants, such as Dollar General, have said publicly that they will not raise prices because they will take a penalty on gross margin expansion in order to keep or gain market share.
The Illusion of Stagflation
Stagflation is defined as high inflation combined with high unemployment and sluggish demand, as coined by British politician Iain McLeod in 1965. In the late 1970s, the United States was hit hard by it, and many economists believe it was sparked by OPEC’s dramatic increase in oil prices.
Stagflation can be triggered by the same factors that cause inflation: a rush of cheap money, low interest rates, and rising prices.
Stagnant demand, exacerbated by excessive unemployment, is, however, a necessary component.
As a result, it appears that we are more likely to be entering a period of stagflation in our current economic situation.
Professor Ronald McKinnon, a senior fellow at the Stanford Institution for Economic Policy Research and a professor at Stanford University, takes us a step farther in understanding the stagflation scenario.
He believes that global monetary fluctuations, as well as the United States’ inability to embrace an exchange rate target, are to blame for the rise in inflation in developing nations, which eventually leads to a rise in the CPI in the United States.
Second, he mentions the massive increase in excess reserves, or “base money,” in the US banking system, which has nearly tripled since 2008 as a result of the Fed pumping dollars into the system with the two stimulus packages, QE1 and QE2 (named after “quantitative easing,” respectively), which were supposed to be used for consumption and business investment, and, eventually, increased employment.
Small and medium-sized business employers, or SME’s, have been the key engine for increasing employment in economic recoveries, according to McKinnon.
Banks are also their primary source of working cash and credit lines.
As previously noted, the banks are sitting on billions of “base money” reserves and are not lending, in addition to the approximately $2 trillion in cash sitting in the coffers of huge corporations that is not being invested in expansion or hiring.
Neither has witnessed a rebound in consumption; in fact, demand appears to be flat.
Not so fast, my friend.
Don’t even think about touching that dial. Don’t be fooled into thinking stagflation is the new normal or reality. Deflation will bring reality to the fore.
The Reality of Deflation
High unemployment, stagnant demand, and overcapacity can all contribute to deflation (or at least exacerbate it). Its economic impact is catastrophic, and its violent downward spiral of self-feeding makes it nearly impossible to reverse, as Japan’s two-decade struggle at the bottom has proved.
And I have some solid evidence to back up my prediction.
According to the Wall Street Journal, supply-side economist and Nobel Laureate Robert Mundell claimed that dollar weakness (induced by QE1 and QE2, and resulting to increased oil and commodity prices a forerunner to broader, more destructive inflation) is not his main concern.
Instead, when QE2 finishes and the dollar begins its inevitable increase later this year, he predicts a return to recession.
He claims that the larger concern should be deflation rather than inflation.
His deflation prediction is based on the fact that exchange rates cause inflation or deflation in economies by raising or decreasing prices for imported goods and commodities.
When the dollar falls significantly against the euro, the world’s second most valuable currency, commodity prices rise, putting upward pressure on US inflation.
When the dollar appreciates significantly against the euro, commodities prices fall, putting deflationary pressure on the economy.
As a result, just as the dollar fell against the euro from 2001 to 2007 as a result of the Fed’s suppression of the federal funds rate to pull us out of a recession, the same dynamics are playing out now, albeit with greater power (including QE1 and QE2) due to the severity of this recession.
Mundell uses monetary incidents to illustrate his idea.
Investors moved wealth into inflation hedges, mainly real estate, in response to the dollar’s collapse between 2001 and 2007, resulting in the housing bubble and the terrible leveraging of global debt.
He says that the bubble broke in 2007, and that the Fed promptly reduced short-term interest rates, causing the dollar to fall even further.
Despite the severity of the subprime crisis, the economy appeared to be improving in the second quarter of 2008, thanks to looser monetary policy.
But, according to Mundell, the Fed made one of its biggest mistakes in history in the summer of 2008, when it halted in decreasing the federal funds rate in the midst of the real estate crisis, which was exacerbated by “mark-to-market” accounting regulations requiring banks to pay short-term losses.
As a result, the dollar gained 30% against the euro in just a few weeks.
According to Mundell, the scarcity of dollars broke the economy’s back, resulting in economic collapse and financial breakdown.
As a result, the Fed is reverting to tried-and-true strategies.
They implement QE1 in March 2009, decreasing the dollar’s value against the euro, and we begin to see signs of recovery.
But, once again, it’s a fantasy, as seen by the fact that they halted QE1 in November 2009, and the dollar has soared over the euro, forcing us back into recession.
So, what does the Federal Reserve do?
They implement QE2, which lowers the dollar and leads us to feel that we are on our way to recovery once more.
Then I question, assuming Mundell’s prediction is correct, what will happen when the Fed finishes QE2 in June, as is expected?
Isn’t the dollar going to shoot past the euro like a yo-yo, as it has twice before?
And, if that’s the case, will we revert to a recession, complete with the dreaded deflation?
Will the Fed play a yo-yo with QE3 if we slide backward again?
I don’t believe so, given the political pressure on our country’s debt and deficit.
Even if the Fed plays the loose money game again, according to Mundell, it will just be a band-aid, not a cure.
His idea is for the US Treasury to set the exchange rate between the dollar and the euro in order to keep the euro price between $1.30 and $1.40.
He claims that when the range narrows to a stable rate, prices would be free of the scourge of unexpected deflation and inflation, allowing investment and planning timeframes to expand in tandem with production levels in Europe and the United States.
But This Time It’s Different And Worse
As much as I respect and admire Robert Mundell’s brilliant perspective, which I believe adds significant weight to my own prediction, I believe there are a few additional and significant differences to be made about the recovery from the recession in the early 2000s and the one we are currently experiencing “from “recovering” And, in my opinion, they merely amplify Mundell’s prognosis.
One significant difference between then and now is that the government, with the support of the Fed, relaxed the money supply in 2003 “Wall Street’s “financial engineers” discovered a new bubble to inflate in order to get the economy growing again: housing.
‘Growing,’ as we now know, was an understatement.
As I previously stated, it was more akin to a legalized Ponzi scheme on steroids.
As a result, the consequences of its demise were cataclysmic.
As a result, Ben Bernanke finds himself in an even worse situation than his mentor.
Worse yet, do you see any fresh growth bubbles arising in which Wall Street may use its alchemy to disseminate risk and outsized rewards around the globe? No, I don’t believe so.
Some economists are speculating that a new tech bubble is forming, this time in its third iteration, with a focus on consumer markets, every price and promotional gimmick you can think of, social networking, and so on.
Regardless of how large this bubble’s potential is, I do not believe it has the leveraging power or global finance capacity to propel entire economies throughout the world, as the housing bubble did.
The second big difference is that overcapacity continues to grow; there are too many stores; there is too much merchandise; and now a million web-site retailers are opening every day on the Internet, all of which will drive deflation deeper, quicker, and longer.
Our “Managed and Flawed Free Market System
Rather than focusing on the demand side of consumer growth (as we have done since WWII), I believe we are now, and have been for some time, confronted with a supply-side dilemma that highlights a key fault in our now’managed’ free market system.
Overcapacity is perpetuated by new business entrants contributing to the supply side at a quicker rate than those exiting, all of which is compounded by slow and slow demand growth.
If this is the case, no amount of stimulus to boost consumption will be enough to stop prices from falling, simply because a new paradigm has emerged, with a permanent disequilibrium of too much supply driving an unending downward pricing spiral.
Everything is always on sale and ships for free, as I’ve explained numerous times.
Retailers’ price structures (good, better, best) have migrated downward.
Even in the premium segment, outlet stores are rising faster than full-price stores.
‘Flash sales,’ ‘Groupon,’ and all other types of on-sale online models are exploding at breakneck speed.
Furthermore, if you wait two seconds, your phone will beep with an advertisement or a friend advising you where you can acquire anything you’re thinking of buying at a lower price.
Housing is, of course, the biggest undertow of them all.
As of this writing, housing values have fallen to the level they were in 2002, thereby wiping out a decade’s worth of equity.
The impact of this continuous decrease on the recovery is severe, as homes are people’ largest investment and a major source of spending cash.
Worse, around a quarter of properties were mortgaged at a higher value than they are now, and the value is continuously dropping.
Experts predict that the declining trend will continue.
To me, this sounds like a deflationary area.
Value is being re-calibrated downward across the board.
It will continue, even as businesses “selectively” boost prices in order to pass on rising expenses.
They’re not going to stick.
The Perpetuating Overcapacity
Even if demand rises, I believe that supply-side excesses will persist because marginal participants do not exit the market soon enough. The unchangeable theories of “Economics 101” are being reversed, and we have no way of tracking or measuring such a fundamental shift. The free market forces that have historically removed surplus are hampered by the following factors:
Which is more dangerous: inflation or deflation?
Consumers anticipate reduced prices in the future as a result of deflation expectations. As a result, demand falls and growth decreases. Because interest rates can only be decreased to zero, deflation is worse than inflation.
Is cost-push inflation stagflation?
In Neo-Keynesian theory, there are two types of inflation: demand-pull (induced by shifts in the aggregate demand curve) and cost-push (driven by changes in the price level) (caused by shifts of the aggregate supply curve). Cost-push inflation, according to this theory, causes stagflation. When a force or situation increases the cost of production, this is known as cost-push inflation. Government measures (such as taxation) or completely external reasons (such as a scarcity of natural resources or a war) could be to blame.
Stagflation, according to contemporary Keynesian studies, can be understood by separating factors that effect aggregate demand from those that affect aggregate supply. While monetary and fiscal policy can help stabilize the economy in the face of aggregate demand changes, they are less effective when it comes to dealing with aggregate supply fluctuations. Stagflation can be triggered by an adverse shock to aggregate supply, such as an increase in oil prices.
What exactly is deflation?
Deflation occurs when the general price level falls to the point where the inflation rate turns negative. It is the polar opposite of inflation, which is all too common.
In most circumstances, deflation is caused by a drop in the money supply or credit availability. Reduced government or individual investment spending may also contribute to this predicament. Due to slack in demand, deflation causes a rise in unemployment.
By preventing extreme deflation/inflation, central banks strive to keep the overall price level constant. To counteract the deflationary impact, they may increase the money supply in the economy. A depression usually occurs when the supply of commodities exceeds the availability of money.
Deflation differs from disinflation in that the latter refers to a drop in the level of inflation, whereas deflation refers to negative inflation.
Inflation, Reflation, Stagflation, Agflation, Disinflation, and Hyperdeflation are other terms for the same thing.