What is stagflation? Meaning of the economic term, what causes it and how it can be resolved - explained

Definition of the term ‘stagflation’ and why the UK economy could be heading for a period of it

Could the UK economy be heading for a period of stagflation?

That’s the concern from economists and company directors following supply chain disruption, inflation pressure on raw materials and staff shortages of late.

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Those factors all contributed to growth in the UK’s private sector slowing to a seven-month low in September, according to new data. The IHS Markit / CIPS Composite Output Index recorded a score of 54.1 so far this month, down from 55.3 at the same point in August. Anything above 50 is seen as a sector or service in growth.

While confidence of company directors in the UK economy has “fallen off a cliff” back down to levels last seen in February 2021 at the height of the third lockdown. Three out of four of the 635 directors syrveyed by the Institute of Directors (IoD) said they expect their costs to be higher in the next 12 months compared with the last year.

So what is stagflation, what causes it, why is it bad and how can it be resolved?

What is stagflation?

Stagflation is an economic term used to describe a period of high inflation and relatively high unemployment during a stagnant demand for products.

These don’t necessarily happen in that order. At the moment, the UK is facing a period of rising prices at a time when expansion in output and new orders is weak.

And, although job creation is high, people to fill those roles are few and far between.

This, coupled with the high cost of goods being passed on to customers, has the potential to create a difficult situation for policymakers to get things back on an even keel.

What causes stagflation?

A sudden shock in the supply of goods can result in a rapid increase in prices.

This was seen during the energy crisis when a shortage of gas led to wholesale prices skyrocketing and many UK suppliers struggling to meet costs.

Unable to pass the expense on to customers, due to the energy price cap which is increasing from 1 October, some providers have gone bust, with others still at risk.

There are other examples elsewhere, too, with the slowdown more acute in manufacturing, where production only rose modestly due to severe supply-chain disruption and signs of demand softening, in light of the HGV driver shortages.

Employment growth in manufacturing slowed as a result of fewer orders and the availability of workers, the IHS / CIPS survey found.

Why is stagflation bad?

Stagnation is a period when there is a disruption to the moderate demand for products, controlled inflation and low unemployment balance.

In manufacturing, the Purchasing Managers’ Index (PMI) for the first half of September hit 56.3, falling from 60.3 in August to the lowest level since February during the last lockdown.

Chris Williamson, chief business economist at IHS Markit, said: “The September PMI data will add to worries that the UK economy is heading towards a bout of ‘stagflation’, with growth continuing to trend lower while prices surge ever higher.

“While there are clear signs that demand is cooling since peaking in the second quarter, the survey also points to business activity being increasingly constrained by shortages of materials and labour, most notably in the manufacturing sector but also in some services firms.”

How can stagflation be resolved?

Once stagnation happens it can be difficult to stop, with policymakers needing to lower inflation and unemployment at the same time.

It is thought that lowering inflation in the long term typically increases unemployment in the short term. Likewise, lowering unemployment in the short term increases inflation in the long term.

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