Rampant inflation has raised fears that the economy is headed for a return to stagflation, but many Wall Street banks such as Goldman Sachs and HSBC believe there are still opportunities for investors to navigate safely in this delicate context.
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What is stagflation?
Stagflation is a term coined in the 1970s, when there was simultaneously high inflation and economic stagnation or high unemployment, according to Jonathan Wright, professor of economics at Johns Hopkins University.
Although there were bad recessions back then, many economists don’t expect a return to anything like this now, he said.
“I think the sense that you had stagflation in the 1970s is not in the cards at all,” Wright said.
However, high inflation prompts the Federal Reserve to raise interest rates, known as monetary policy tightening. With that, it’s “very likely” that the unemployment rate will rise “a bit” from the 3.6% it is now, Wright said.
The result could at least be a mild recession, he said.
Stagflation can occur if a recession sets in before inflation has come down to where the Fed wants it, Wright said. For example, if unemployment were to rise to around 5% and consumer price index inflation was also above 5% in 2023, that would be a kind of stagflation, but not to the degree that we have experienced in the 1970s, he said.
“That would definitely mean the job market would be a lot less hot than it has been,” Wright said.
In the short term, the labor market could cool simply by having fewer vacancies, he said.
What is the probability of stagflation?
Despite polls sounding the alarm about stagflation, not everyone agrees it’s inevitable.
“It doesn’t seem like a high probability,” said Josh Bivens, research director at the Economic Policy Institute.
To have stagflation, you need both high unemployment and high inflation, which Bivens does not consider likely.
“If we had a situation where unemployment was going up quite sharply, I actually think that would probably cause inflation to fall quite sharply,” Bivens said.
A more likely scenario is that if we end the year with a series of interest rate hikes by the Federal Reserve, we could be in a recession by 2023, he said.
“If that happens, I expect inflation to slow pretty quickly,” Bivens said.
How to prepare for a recession or stagflation?
People shop at a grocery store on June 10, 2022 in New York City.
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A combination of inflation and shrinkage, where commodity companies reduce the content of everything we buy, means that people’s money just doesn’t go that far now, says certified financial planner Ted Jenkin. and CEO of oXYGen Financial in Atlanta.
Now, stagflation is also a possibility customers are wondering about, Jenkin said.
“I think it’s inevitable that we’re going to go into a recession,” he said. “Whether it’s a mild recession or we go into stagflation will be the big question.”
Therefore, now is the time to review your personal financial plan.
“Now is an absolute time for people to batten down the hatches and strengthen the foundations of their financial house,” Jenkin said.
Try to aim for at least six months of emergency spending in the event of a downturn, he said. Also, make sure you’ve prepared a recent budget to see if there are any places you can cut spending.
Plus, look at any variable-rate debt you might have — credit cards, mortgages, student loans — and see if you can reduce those balances or refinance them. Now that interest rates are about to rise, these balances will become more expensive.
Plus, now is a great time to invest in yourself to be more professionally marketable if layoffs become the norm.
“Make sure you’ve really upgraded your skills and your skills or your education so that if the job market tightens, you’re marketable,” Jenkin said.