Stagflation vs recession: Which is more detrimental to the economy?

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Stagflation vs recession: Which is more detrimental to the economy?

 Stagflation vs recession: Which is more detrimental to the economy?
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Highlights

  • Stagflation and recession have become commonly used terms over the last few months.
  • These economic phenomena are associated with an economic slowdown, high unemployment, and rising inflation.
  • Stagflation can be a more worrisome event than recession as it includes prolonged inflation and economic contraction.

Stagflation and recession are the two terms that have increasingly remained in the limelight in recent times. Both have a harmful impact on the economy and can lower economic growth. With a vast expanse of historical data available, experts can now recognise these patterns in the economy with much ease. In fact, the historical data has been the stepping stone for the current forecasts of stagflation and recession hitting the global economy.

The majority of the fears surrounding a possible recession in the US have been based on the elevated inflation rate. According to the US Bureau of Labour Statistics, the inflation rate hit 8.6% over the 12 months to May 2022. This is higher than many other advanced economies, including Australia.

However, inflation is not the only problem facing the US and the global economy. Global headwinds have arrived on top of an existing cost-of-living crisis facing most countries. These headwinds include supply chain issues, rising commodity prices, lockdowns in China and an energy crisis.

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What is a recession?

A recession is a scenario under which an economy is undergoing a temporary slowdown, which can be corrected with additional stimulus. A recession is a common phenomenon and is often experienced temporarily by economies.

Interest rate hikes and recession: How are they related?

In other words, a recession is the part of the economic cycle that is generally associated with slower economic growth, higher unemployment and falling wages. Economies are used to experiencing a recession, with the last recession surfacing after the COVID-19 lockdowns hit the global economy.

In technical terms, an economy is said to be in a recession when the GDP growth falls over two consecutive quarters.

What is stagflation?

The rare occurrence of stagnated economic growth alongside high unemployment and elevated inflation is termed stagflation. Most economies have been able to skirt away from stagflation even as the economic situation has been extremely challenging.

The term stagflation represents a mixture of the words – inflation and stagnation. Earlier, economists believed that stagnation and inflation could not occur together due to an equation known as the Phillips curve equation. However, it was not until the 1970s that economic conditions spiralled into a stagflation-like scenario and compelled economists to believe that stagflation is a very real possibility.

What are the key differences between recession and stagflation?

  • Reasons for their cause: Both recession and stagflation can arise during an economic shock. While stagflation is mostly associated with supply-side shocks, a recession can occur when an unexpected event takes place on a large scale. Government policies may also sometimes trigger a recession, especially if they are aimed at reducing consumer demand.
  • Regularity of occurrence: A recession is a far more common phenomenon than stagflation and is often easier to deal with. However, authorities are often highly worried about stagflation as it is extremely difficult to recoup.High unemployment is a striking feature of both recession and stagflation.
  • Effect on GDP: GDP growth falls during times of both stagflation and recession. However, the economic slowdown caused by stagflation could last longer than that caused by a recession. In stagflation, GDP can grow in some instances and fall in other periods. However, a recession is only marked by a falling GDP.
  • Inflation: While high inflation is a common occurrence during recessionary phases, it can also fall when demand for goods and services is lower. A similar phenomenon is visible in the mid-2022 period as lower demand for housing has led to a decline in housing demand and, consequently, a decline in housing prices. Inflation is high in times of stagflation and may even take years to start reducing.
  • Recent examples: Stagflation had not occurred since the 1970s, when an oil supply shock occurred. However, the latest example of an economic recession was visible in the post-pandemic period when GDP contracted over many months in multiple economies.

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