What Is The Difference Between Stagflation And Recession?
This article is part of our guide on buying real estate during a recession, available here.
You must know the difference between stagflation and recession to steer investments away from low-yield storms. While stagflation and recession describe declining economic conditions that negatively impact business profits and personal wealth, they’re not interchangeable. Stagflation is so strange and chaotic that economists once thought the concept was impossible.
Next, we’ll break down the core differences between a recession and stagflation to make it easier to tell what the economy is doing.
What is a Recession?
A recession is a period of economic stagnation. Most economists “call” a recession when they see two back-to-back quarters of declining gross domestic product (GDP). Recessions aren’t necessarily uncommon. In the United States, there’s been about a dozen since 1945. Hundreds have happened in economies around the world throughout the past 60 years.
Most people remember the Great Recession, which lasted 18 months from December 2007 through June 2009. In addition, there was a “mini” two-month recession during the Covid-19 pandemic. Next, we’ll cover the “sibling” economic downturn to a recession known as stagflation.
What Is Stagflation?
Stagflation describes a period of stagnant economic growth accompanied by high inflation and high unemployment rates. As you may have guessed, the word stagflation combines “stagnation” and “inflation” and combines the worst aspects of a booming and busting economy: rising prices and rising unemployment. Stagflation is rare compared to recessions.
The last considerable stagflation period in the United States occurred during the 1970s, caused by rising oil prices and a sharp reduction of the money supply. Those familiar with the era will recall spiraling prices and wages accompanied by sluggish economic performance. By 1980, inflation had reached 14%. It took the U.S. Federal Reserve raising interest rates that triggered a recession before the economy would again even out to produce stable long-term growth during the 1980s and 1990s.
“Stagflation offers a worst-of-all-possible worlds scenario of weak growth and sharply rising prices,” according to analysts. In addition to seeing inflationary conditions staying, for the time being, experts looking at today’s economic outlook also see Fed rate hikes creating a likely scenario for recession. Next, we’ll examine the impact stagflation has on interest rates.
What Happens to Interest Rates During Stagflation?
Interest rates tend to rise sharply during stagflation. In most cases, the government raises interest rates to curb runaway inflation. The goal is to try to reduce the economy’s liquidity to slow down economic activity and demand.
It can be hard to see what makes stagflation and inflation different when both have similar consequences, making it difficult to understand what assets do well in stagflation. Next, I’ll break down the key ways to spot the differences between inflation and stagnation.
What is the Difference Between Stagflation and Recession?
While a recession is a straight decline, stagflation contains a cocktail of factors that lead to high inflation, high unemployment, and stagnant growth. Take a look at the following characteristics of both:
- Stagflation is usually triggered by an economic “shock” that dramatically changes monetary policies. The pandemic is a perfect example. We had the gas crisis of the 1970s before that.
- While stagflation isn’t the same as recession, stagflation can include periods of recession.
- Stagflation is rare. Many decades can pass without it.
- Stagflation can linger. The stagflation period that started during the 1970s remained through the 1980s.
- Inflation is painfully high during stagflation.
- A high unemployment rate is a telltale sign of stagflation. The core reason is that companies are combating higher production, operational, and wage costs.
- Recessions are when two consecutive quarters of negative GDP growth follow a period of slow economic growth.
- Recessions typically occur when financial bubbles burst. This can be due to a government’s response to an overheating economy to a catastrophic event.
- Recessions are relatively common. The United States experiences recession to some degree about once every decade.
- Recessions can be quick. Many last between six months and a year. While a recession may be brief, it can take an economy years to get over the aftershocks.
- Inflation tends to tumble during a recession due to lower demand for goods and services that drives down prices.
- Unemployment rate increases during a recession.
Next, I’ll break down which one the average person needs to worry about more.
Related Read: Where to Invest in a Recession
Is Stagflation or Recession Worse?
While both stagflation and recession negatively affect personal finances and businesses, economists generally consider stagflation to be more painful. The simple reason is that stagflation can linger much longer than a recession.
The consequences of runaway stagflation include lower purchasing power, long-term high-interest rates, disjointed monetary policies, and sustained high unemployment.
Frequently Asked Questions About The Differences Between Recessions & Stagflation
During stagflation, investors need to focus on inflation-proof investments. Historically, property values and rents outpace inflation. This is one of the reasons why investing in multifamily properties is considered a wise hedge during stagflation.
The dollar’s purchasing power erodes annually, with normalized inflation of 2%-3%, and during inflationary periods that erosion of purchasing power is accelerated. Therefore cash is the worst instrument to hold during stagflation or a high inflationary market. Cash and bonds provide yields we’ll far below the rate of inflation. Smart investments are ones that either keep up with or outpace inflation. This is why many investors focus on rental income that rises with the pace of inflation.
Stagflation vs Recession - Conclusion
Stagflation is considered a constellation of pain points that can cause the economy to spiral into madness. A recession is considered “tame” compared to stagflation, even though it creates similar pain points related to high unemployment, slow growth, and low stock yields. For investors, it can be scary to watch investments lose value against the pace of inflation.
When navigating investments through stagflation and recession, we can only act on what history shows us. We know that real estate investments often perform as “safe harbors” against chaotic stock trends simply because the need for housing doesn’t go away just because the markets are wonky. If you’re interested in passively investing in private value-add multifamily investment opportunities to hedge against stagflation, join the investor club at Willowdale Equity today.
- Investopedia, “How the Great Inflation of the 1970s Happened“
- Harvard Business Review, “Weighing the Risks of Inflation, Recession, and Stagflation in the U.S. Economy“
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