Stagflation refers to slow or stagnant economic growth coupled with high and stubborn inflation. Business literature suggests that stagflation is accompanied with high unemployment. I respectfully disagree on this point. Given that stagflation is driven by insufficient supply, there may or may not be high unemployment depending on demographics. For instance, if a country has an aging population, and therefore a correspondingly low workforce participation rate, those of working age may be mostly employed but their production of goods and services may not meet a consumer demand that includes a large and growing number of retirees. If there is a labor shortage, economic growth will be slow or stagnant, and the supply-demand imbalance that persists will cause inflation.

Stagflation is not a new phenomenon

Although it seems unusual for slow economic growth and high inflation to coexist, this situation is not unheard of. In the United States, stagflation occurred twice in modern history, namely from 1974 to 1975, and from 1978 to 1982. During these periods, the gross domestic product (GDP) of the United States contracted while inflation was high. Following misguided monetary and fiscal policy decisions that aggravated inflation, very high interest rates and severe recessions were needed to lower inflation to acceptable levels. Economic growth and relative price stability resumed afterward.

Cases of stagflation are happening in some developing countries where inflation is high and economic growth is limited or contracting (Table 1). Selected examples attest that stagflation is not necessarily accompanied with high unemployment. In general, high inflation in developing countries is mostly driven by a limited supply of goods and services due to insufficient business investment and/or a lack of skilled labor. When these conditions are accompanied with limited confidence in the local currency, there can be hyperinflation as measured in that currency. Such is the case with Argentina, Lebanon and Venezuela, and to lesser extents with Sri Lanka and Turkey.

Stagflation is a function of supply economics

Contrary to popular belief, inflation is not always the result of excessive demand, rapid economic growth and low unemployment. Inflation can also be driven by an insufficient supply of goods and services, inside an underperforming or stagnant economy, with or without high unemployment among those willing and able to work. Table 2 highlights the differences between the two types of inflation. The first type is conventional inflation, but it should perhaps more appropriately be called “growthflation” to reflect that inflation is taking place in a growing economy. The other type of inflation is stagflation, namely inflation that occurs in a slow, stagnant or shrinking economy. Unemployment is conditioned by economic activity, but it is also greatly affected by demographics such as aging populations, workforce participation, workforce health conditions and immigration.

Stagflation is caused by issues or challenges that limit or harm the ability to offer goods and services. A sub-performance in the production and supply of goods and services causes this type of inflation, to the extent that the demand for goods and services is not met. Examples of factors that negatively affect the production and supply of goods and services include:

• Supply shocks – supply chain problems such as those experienced during Covid-19
• Unfavorable trade policies – trade disputes and embargoes negatively affect supply
• Scarcity of resources – scarce natural resources increase costs and limit production
• Demographic imbalances – aging populations and low workforce participation limit supply
• Unskilled labor – vacant positions that remain unfilled due to skilled labor shortages
• Lack of productivity – aging technologies, lack of automation, disengaged workers, etc.
• Excessive regulations – regulations that discourage business investment in key industries
• Lack of competition – monopolies, oligopolies and cartels that limit production to raise prices
• Inadequate infrastructure – unreliable power sources, inadequate road systems, etc.
• Limited entrepreneurship – lack of innovation, and few small businesses and start-ups
• Excessive taxation – businesses that move production elsewhere to reduce income taxes
• Misguided industrial policies – unfavorable business conditions created by governments
• Absent rule of law – Corrupt government officials, unreliable courts systems, etc.

As a general rule, any factor that limits or reduces the ability to offer goods and services, and by extension limits or reduces economic growth, at a time when the demand for goods and services is unchanged or growing, causes stagflation. The economy stagnates or shrinks. But because the demand for goods and services remains unchanged or relatively strong, there is inflation despite the fact that the economy is not growing. Those are the dynamics of supply economics.

Many factors currently point in the direction of supply-driven inflation (stagflation). These factors include geopolitical conflicts, trade sanctions, the reshoring of production to friendly and reliable countries, tight labor markets in western economies, acute shortages of skilled labor in key industries, aging populations with longer life expectancies, the increasing frequency and severity of climate change catastrophes, major readjustments required to limit greenhouse gas emissions, the possibility of additional pandemics, and cartels limiting supply to maintain higher commodity prices.

Chief economists are worried about stagflation

Last year, World Bank Chief Economist Indermit Gill mentioned that he is concerned about “generalized stagflation” in the global economy.¹ Surveys of chief economists conducted by the Securities Industry and Financial Markets Association (SIFMA) echo his concern.² The latest SIFMA survey conducted in December 2022 indicates that 78% of chief economists believe that stagflation is the greatest long-term risk for the United States economy, slightly down from 80% in June 2022 (Figure 1). The factors perceived as most susceptible to create long term inflation are large salary and wage increases, the reversal of globalization, sustained supply chain breakdowns, and the costs associated with moving supply chains to the United States (Figure 2).

Central banks and governments must take notice

It is very important to realize that supply issues and challenges have as much effect on inflation as excessive demand. As such, it is critical for central bankers and government leaders to understand the root causes of inflation, in order to implement appropriate solutions. Misguided monetary and fiscal policy decisions make matters worse. The track record of central banks and governments in tackling stagflation has not been good in the past, mostly because it was not well understood. There continues to be much evidence of confusion among those responsible for setting policy.

While both limited supply and excessive demand cause inflation, it is widely recognized that supply-driven inflation is a much bigger concern for the foreseeable future. It is quite clear that western economies are challenged with many factors that create stagflation. The signs are there. The annual inflation rate of the United States was 5% for the 12 months ending in March 2023,³ well above the central bank target of 2%. During the same period, gross domestic product increased by only 1.1%.⁴ Interestingly, the unemployment rate of the United States was 3.4% at the end of April, the lowest level since 1969.⁵ These are clear signs of stagflation without high unemployment.

Unfortunately, monetary and fiscal policies are much better adapted at conditioning demand than influencing supply. Central bankers and government leaders are also much less experienced in dealing with supply-driven inflation. In addition, the solutions for addressing supply-driven inflation are less obvious and more difficult to implement. All of these conditions are cause for concern.

There may be public outcry if interest rates remain high to curb inflation, while governments adopt monetary and fiscal policies aimed at stimulating business investment, production and productivity. Very few elected officials and citizens have a clear understanding of the policy measures needed to effectively mitigate stagflation. Significant pushback can be expected from those who do not understand the need to stimulate supply while curbing demand. Moreover, curbing demand while not stimulating supply inevitably leads to a lower standard of living. The lack of business investment and production, and the poverty in underdeveloped countries, are a case in point.

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¹ Reuters, World Bank’s Gill worried about ‘generalized stagflation’ in global economy (September 15, 2022)
² SIFMA Research, 2022 End-Year US Economic Survey – Forecasts from the SIFMA Economist Roundtable (Dec 2022);
and 2022 Mid-Year US Economic Survey Forecasts from the SIFMA Economic Advisory Roundtable (June 2022)
³ U.S. Bureau of Labor Statistics, Consumer Price Index (April 12, 2023)
⁴ U.S. Bureau of Economic Analysis, Gross Domestic Product, First Quarter 2023 (Advance Estimate), (April 27, 2023)
⁵ Jeff Cox, Job growth totals 253,000 in April, beating expectations even as the U.S. economy slows (CNBC, May 5, 2023)