How to protect your finances from stagflation

Stagflation or recession-Inflation is an economic phenomenon characterized by persistently high inflation, high unemployment and stagnant demand in a country’s economy. During the particularly severe economic conditions in the 1970s, rising inflation and declining employment suppressed economic growth in the UK and the other seven major market economies, and investors in the stock market suffered heavy losses as a result.

Key points

  • Stagflation is an economic phenomenon characterized by persistently high inflation, high unemployment and stagnant demand in a country’s economy.
  • If your portfolio has more active investments or no diversification, and the economy appears to be approaching a period of stagflation, then it may be time to reduce your risk.
  • Stagflation may be a reason to postpone large purchases (such as home purchases), especially if the area where you live is experiencing a real estate bubble.
  • A sound long-term financial plan is the best way to protect your finances from stagflation; if you keep living within your means, stagflation should not have a significant impact on your lifestyle.

In 1965, the British Conservative Party politician Iain Macleod (Iain Macleod) used the term stagflation in a speech to Parliament, the media adopted it and began to mention the influence of the country from 1973 to 1982. Use it for economic conditions. The term stagflation is a hybrid of the two words stagnation and inflation. Since then, economists have studied the factors that lead to stagflation and developed methods to measure stagflation. Their findings also include practical advice on how investors can protect their finances during stagflation.

How to measure stagflation?

Stagflation is not measured by a single data point, but by checking the direction of various indicators over a long period of time. Rising prices and rising unemployment are two of the data points. The direction of one of these indicators does not necessarily indicate the possibility or existence of stagflation. Instead, these phenomena are considered comprehensively.

Increase in the cost of goods and services

Increases in the cost of food, energy, or other individual items are generally not considered signs of stagflation. However, the widespread increase in the cost of goods and services may be an indicator. Investors who want to predict these increases can monitor the producer price index (PPI) and consumer price index (CPI) trends.

PPI measures the average change over time in the sales prices of domestic producers of goods and services. From the perspective of investment analysis, it is very useful for analyzing potential sales and profit trends in various industries. From the perspective of economic analysis, changes in PPI indicate whether the cost of producing goods is rising or falling.

CPI measures the weighted average price of a package of consumer goods and services. Over time, CPI can gain insight into the direction of consumer prices. CPI is often referred to as “overall inflation.” The normal increase in CPI is less than 2% per year. When this number exceeds this number, investors begin to worry about inflation.

Price increases are not the only indicator of rising prices that indicate the possibility of stagflation. Rising unemployment is another indicator.

Productivity decline

The decline in gross domestic product (GDP) and productivity are indicators of economic downturn. GDP tracks the monetary value of all manufactured goods and services produced within a country/region within a certain period of time. In a healthy economy, this number usually rises. Productivity is an economic indicator that measures input and output per unit. Input includes labor and capital, while output is usually measured in terms of income and other GDP components (including corporate inventories).

Productivity indicators can be reviewed collectively across the economy or individually reviewed by industries to review trends in labor growth, wage levels, and technological improvements. Declining productivity is usually a sign of economic downturn.

Why does stagflation occur?

Keynesian, monetarist, and supply-side economists have put forward a variety of theories about why stagflation occurs.

Keynesian economists blamed supply shocks for stagflation. For example, they cited soaring energy costs or food costs as the root cause of stagflation economic problems. Monetarist economists believe that the excessive growth of the money supply has led to a situation where too many dollars are chasing too few commodities. Supply-side economists blamed high taxes, over-regulation of companies, and a continuous welfare state that allowed people to survive without having to work. Other theories hold that stagflation is only a natural part of the business cycle in the modern economy, or that the political or social structure should be blamed on stagflation.

Once stagflation occurs, it is not possible to predict, avoid and contain it, which shows that the exact force that causes stagflation is unclear. Once stagflation occurs, the effective method to solve stagflation is also unknown. In the 1970s, despite the government’s best efforts to quell stagflation, stagflation in the United States still existed. When the Fed raised interest rates to the point where many sectors of the economy could not borrow, this trend was finally interrupted and the country fell into a deep recession.

How to protect your finances from stagflation

A sound long-term financial plan is the best way to protect your finances from stagflation. If you live within your means, stagflation should not have a major impact on your lifestyle.

When stagflation does occur, don’t panic, sell stocks and bonds, and invest in rare art, gold, or other unusual commodities. Stagflation is not a sufficient reason to completely abandon reasonable investment strategies. However, if your portfolio has more aggressive investments or is not well diversified, it may be time to reduce risk.

Stagflation can also be a reason for delaying large purchases (such as buying a house), especially if the area where you live is experiencing a real estate bubble. However, if you have a job and have money to spend, you should continue to buy regularly. You should also continue your savings and investment habits.

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