What could it mean for your business?
Stagflation is a combination of stagnant output and rapidly rising prices.
In economics, stagflation or recession-inflation is a situation in which the inflation rate is high, the economic growth rate slows, and unemployment remains steadily high. It presents a dilemma for economic policy, since actions intended to lower inflation may exacerbate unemployment.
- Stagflation occurred in the 1970s following the tripling in the price of oil.
- A degree of stagflation occurred in 2008, following the rise in the price of oil and the start of the global recession.
Stagflation has been in the press a lot lately as financial analysts fear the toxic cocktail of rising prices and slow economic growth.
Post-pandemic supply chain bottlenecks, combined with rising energy prices and the economic effects of the war in Ukraine are seen as the main contributors to the current economic challenges.
The rise in energy prices is already starting to impact the profit margins of businesses. There is also an intense shortage of human capital which is driving up the cost of hiring good people as firms compete to attract the best and brightest talent.
The cost of borrowing is also starting to increase as interest rates creep higher and higher. This will put businesses under increased financial pressure. The tone from economists in the financial services sector is cautious, with further interest rate increases expected later this year. Consumer confidence is falling somewhat and people are tightening their belts and spending less where they can.
All of the above combines to make the current trading environment very difficult for businesses. The best way for businesses to combat stagflation is to find ways to improve productivity. Investing in more efficient software or process improvements can help to streamline your business operations and increase productivity without hiring additional employees.
There are no easy solutions to stagflation.
- Monetary policy can generally try to reduce inflation (higher interest rates) or increase economic growth (cut interest rates). Monetary policy cannot solve both inflation and recession at the same time.
- One solution to make the economy less vulnerable to stagflation is to reduce the economies dependency on oil. Rising oil prices are the major cause of stagflation.
- The only real solution is supply-side policies to increase productivity, this enables higher growth without inflation.
- In 2010/11, the Central Bank decided to keep interest rates low (at 0.5%) because they felt low growth was a bigger problem than some temporary cost-push inflation.
Businesses should also focus on bolstering their balance sheet. During a period of stagflation, revenue may flatline while costs keep going up. As such, businesses should prepare for tough times by minimizing debt and building cash reserves. Your firm should focus on cashflow. Chase down debts and tighten up your payment terms. It can also help to negotiate longer payment terms with your own suppliers.
Stagflation is a tough environment in which to operate any business. Costs rise and sales slow or even decline. Use it as an opportunity to review your current business model, make tough decisions and build your business into a stronger, leaner enterprise.