The Imminent Loom of Stagflation

The Imminent Loom of Stagflation

Blog #1 from our campaign "The Future of the Economy"

The U.K. inflation rate has hit its peak since 1992 at 7% in March 2022. This may cause hysteria across the country, but the question that remains in many peoples’ minds is simply… ‘what does this mean?’.


What does it mean for job security? What does it mean for everyday consumers? And what does it mean for businesses and business owners? Well… let’s take a look.

Inflation for Dummies

Let’s start off by looking at why inflation rates are this high. To create a general understanding, inflation (which is defined as the ‘general increase in prices of goods and services in an economy’, or, alternatively the ‘decline of purchasing power of a given currency over time’, is influenced by three factors: production prices, demand and expansionary fiscal policy (yes, *big sigh*… economics time).

On the supply side, price hikes in production costs such as raw materials or wages, cause the prices of goods and services to increase. On the demand side, a surge in demand for products and services can cause inflation as consumers are WILLING to pay more for these products/services.

So why is inflation so high now?

In the current economic climate, inflation is at an all-time high largely due to the hike in energy prices brought about by the Russian-Ukrainian war. With Russia being a key player in provision of oil and gas, and facing stringent sanctions from the world, the cost of fuel has increased, which, as we all know well enough, has driven up prices of everything else.

Interest Rates. What they do.

The interest rate is used as a primary tool by central banks to help manage inflation. By increasing an interest rate (the cost of borrowing money), consumer and business spending will lessen which will reduce the demand for products and services, bring down prices and lower inflation. Unfortunately, there are lags between interest rate changes by policy drivers and inflationary drivers.

This means it is important for policy makers to identify the potential for an economic shock… which is quite difficult, especially when we see instances of an abrupt war such as the Ukrainian-Russian war. This often results in instances of stagflation.

Stagflation. A downhill spiral.

Bringing it back to the U.K., in response to soaring inflation, the Bank of England has raised the base rate of interest from its record low of 0.1% in December to its current level of 1% in May – the highest in 13 years!

Moreover, if we take a look at the labour market – average UK wages are increasing whilst unemployment has risen to pre-pandemic levels at 3.8%. At the same time, the Brexit agreement has led to mass skilled labour shortages across the U.K (remember high prices of raw materials and wages equal higher inflation). This, coupled with rising energy and commodity prices, has led to soaring inflation across the U.K.

 

So, the danger is that, with price hikes and supply drops, economic output and growth remains low, meaning that purchasing power falls and unemployment increases, stagflation will occur.

Stagflation, in simple terms, means that the British economy is not growing whilst goods and services are just getting more and more expensive. And we’ve seen this in the past – with the 1970’s oil crises which sent oil prices soaring by 300%.

And just to put it into context – stagflation is worse than a recession, because it combines the worst outcomes of a recession with higher prices and fewer jobs. This means it is difficult to solve, where CB’s have to lower the money supply whilst encouraging businesses to hire more staff to keep unemployment low – a near impossible task for many Monetary Policy decision makers!

To sum it up

  • The Ukrainian war has led to supply shortages and rising inflation
  • Brexit and Covid have led to higher-than-usual unemployment levels
  • Businesses are struggling to hire staff due to higher interest rates, exacerbating the unemployment issue
  • The U.K. economy is struggling to budge – showing a mere 0.1% increase in GDP from Jan – Feb 2022.
  • Even the Bank of England is stumped - The Bank warned bleakly that it's "unable to prevent" a fall in profit margins and in household incomes due to the huge rise in energy prices
  • All-in-all, it is looking pretty grim, and stagflation is definitely among us.