You've heard of recessions. You've heard of inflation. But what about their shadowy cousin, stagflation? It may be the most troublesome of all. Stagflation is a period where economic growth becomes stagnant or ceases activity. This raises concern for small businesses because it can lead to higher costs and lower consumer spending.
During the 1970s, the economy experienced stagflation, this was a unique and difficult situation, as traditional economic theories had not predicted the simultaneous occurrence of inflation and economic slowdown. The main causes of stagflation during this period were two oil price shocks, tight monetary policy, and supply-side constraints such as labor strikes and rising costs of raw materials. The stagflation of the 1970s had a profound impact on the global economy and led to a reassessment of economic theories and policies.
Although we haven’t seen a period of stagflation since the 1970s, could our economy be heading in that direction? This guide explains what stagflation is, how it affects small businesses, and what you can do to combat stagflation as a small business owner.
- What is stagflation?
- What is the difference between stagflation and inflation?
- What is the difference between stagflation and recession?
- What causes stagflation?
- How stagflation affects small businesses
- How to beat stagflation: 6 tips for small business owners
- Stay prepared with QuickBooks for potential economic difficulties
What is stagflation?
Stagflation refers to constant high inflation combined with high unemployment and inactive demand in a country’s economy. The term was first introduced in 1965 by Iain Macleod, a British politician. During an economic downturn in the UK, Macleod made a statement calling the period of stagnation and inflation a “stagflation situation.”
The term was introduced to the United States in the 1970s when an increase in government spending led inflation to rise to 6%. On top of that, an oil crisis in the US caused oil prices to increase, which pulled the economy down and made inflation rates reach over 7%. President Nixon tried to control prices, but it ended in poor growth and inflation, which led to—you guessed it—a period of stagflation.
Economists now define stagflation as occurring when the economy experiences a combination of high inflation and high unemployment rates. When these economic periods collide, economic growth becomes stagnant. Hence the term "stagflation," which combines inflation and stagnation.
Also read: Explore more accounting terms for small business owners.
What is the Difference Between Stagflation and Inflation?
Inflation occurs when the cost of goods and services increases, potentially leading to a decrease in purchasing power. Usual inflation rates of about 2% each year are normal and often considered a natural way to maintain a healthy economy.
Stagflation, on the other hand, occurs when economic growth slows and becomes stagnant as a result of high inflation and high unemployment rates. So, high inflation is one of the factors that make up stagflation. High inflation rates combined with slow economic growth pose a cause for concern. So, stagflation occurs when high inflation combines with economic stagnation.
What is the Difference Between Stagflation and Recession?
Stagflation and a recession are both a result of an economic downturn, however, a period of stagflation is rare.
Different countries around the world have experienced many recessions that are often a typical part of the economic cycle. Recessions occur when the economy is experiencing a temporary decline in economic activity. This can lead to an increase in unemployment rates due to the decrease in demand for goods and services.
As opposed to a decline in economic growth—which occurs during a recession—stagflation is a result of a stagnant economy combined with high unemployment and high inflation.
What causes stagflation?
Aside from a stagnant economy, high inflation and unemployment rates, there are a few other contributing factors that many economists believe can bring about a period of stagflation.
Supply shocks happen when there is a sudden change in the supply of a product or service, usually resulting in a change in price. These changes are usually the result of unforeseen events like natural disasters or, more recently, a global pandemic. There are two types of supply shocks—negative and positive.
- Positive supply shock: A sudden increase in supply, causing prices to decrease.
- Negative supply shock: A sudden decrease in supply, causing prices to increase.
When referring to stagflation, the disruption in the supply chain leads to negative supply shocks that decrease the output of goods and leads to an increase in prices which can slow economic growth.
Many also believe that poor economic policies cause stagflation. To combat bad economic periods, the government will often make decisions regarding monetary policies in an attempt to balance the economy, but one wrong decision could do more harm than good.
For example, let’s say the government increased business taxes. This can lead to businesses:
- Increasing their prices to keep up with the increase in taxes
- Cutting back spending on labor costs, which can lead to an increase in unemployment
- Losing employees who seek higher wages to keep up with rising costs
Changes in economic policies can contribute to high inflation and high unemployment—two of the primary factors contributing to stagflation.
During periods of high inflation, there tends to be a spike in interest rates in an attempt to slow inflation. However, to combat a slow economy, policymakers may lower interest rates to encourage consumer spending, and if rates become too low, it can worsen inflation.
- When interest rates increase: It makes it harder for businesses to gain funding, forces them to increase their prices, and lowers consumer spending.
- When interest rates decrease: Business and consumer spending increase, causing inflation due to higher demand.
How stagflation affects small businesses
Now that we’ve discussed what stagflation is and its causes, how does it affect small businesses? Here are a few major effects stagflation can have on a small business.
- Higher costs: When an economy experiences inflation, it leads to a rise in costs. When business owners face higher costs and expenses, they often have no choice but to increase their prices to combat this.
- Difficulty securing funding: When an economy faces stagflation, interest rates tend to rise. This means that the cost of borrowing funds increases, making it more difficult for businesses to secure funding.
- Decreased consumer spending: When inflation is high, customers cut back on discretionary spending due to the increase in the cost of basic items. In fact, a recent QuickBooks survey found that 58% of consumers say they may be forced to cut back on spending due to high inflation rates.
- Supply chain issues: When supply chain issues occur, it leads to an increase in demand and a decrease in supply, making it difficult (and more competitive) for small businesses to get the supplies they need.
How to beat stagflation: 6 tips for small business owners
If faced with an economic period like stagflation, it can be hard for small businesses to stay afloat. However, there are many ways you can prepare so your business makes it through. Here are six ways to stay prepared and beat stagflation as a small business owner.
1. Minimize business expenses
Although you can’t stop inflation, you can reevaluate your business expenses and look for ways to cut down on spending. Here are a few ways your small business can minimize your expenses:
- Reduce office supply expenses and shop around to ensure you’re getting the best deal.
- Reduce traditional marketing spending and focus on cheaper alternatives, like upping your social media marketing strategy.
- Go paperless and switch to online billing and payment systems.
- Look for ways to cut down production costs, like shipping expenses.
- Take advantage of small business discounts.
2. Stay on top of your finances
Staying on top of business finances is crucial during economic hardships. As costs continue to rise and cash flow becomes slow, you’ll want to ensure you’re financially prepared.
To keep your finances in order, focus on
- Keeping debt low
- Building and maintaining a financial cushion to fall back on
- Closely monitoring your balance sheet to ensure you’re in a healthy financial position
3. Reevaluate your prices with a focus on quality
To keep up with inflation, you’ll likely need to reevaluate your pricing strategy. As costs of goods and supplies increase, raising your prices can help offset the rise in costs. Raising your prices without making any changes to your products may leave your customers wondering why they should pay more. The goal is to focus on quality.
When reevaluating your prices:
- Do some competitor research to see how much other businesses in your industry are charging.
- Put your focus on improving quality so your customers have a clear understanding of why they should pay more for your products or services.
- Look for creative ways to increase prices without buyers noticing, like offering product bundles.
4. Improve productivity
Efficiency is key during a period of stagflation. This means looking for ways to maximize productivity and streamline your processes. When your business is more productive, you can produce goods and services at a faster (and often more affordable) rate.
When thinking of how your small business can be more productive, consider investing in:
- Online software that streamlines your business processes
- Technology or tools that can reduce production time
- Automation software that eliminates time spent on mundane tasks
5. Ensure all team members are being utilized
Making sure you're utilizing all your employees effectively is an important way to prepare for stagflation. Hiring may naturally start to increase during periods of growth and expansion. However, when the economy faces economic downturns like a recession, it can lead to the elimination of some employees to cut down on costs.
To avoid losing team members during these hardships, it’s important you delegate tasks effectively and only hire new employees when there is an absolute need.
When assessing your business needs, ask yourself these questions:
- Is there a specific position that you need to fill or create?
- What needs do I need to fulfill currently?
- Based on these needs, are there any current team members that can take on the responsibilities?
- Is hiring a new team member a must?
Not only can this ensure you’re utilizing all team members efficiently, but it can also cut back on unnecessary spending—allowing you to put that money back into other aspects of your business.
6. Remain customer-centric
Even during challenging financial times like stagflation, remaining customer-centric and emphasizing your relationships with your customers can go a long way. Since consumer spending will likely decrease, you’ll want to stay prepared by paying attention to your customers’ needs.
Here are a few ideas to consider when remaining customer-centric during a time of stagnation:
- Implement a rewards program or offer discounts to encourage repeat business.
- Launch limited-time products or services that encourage spending.
- Keep an eye on consumer trends to stay ahead of your competition and maintain customer loyalty.
- Remain open and flexible to the changing needs of your customers.
Stay prepared with QuickBooks for potential economic difficulties
Although economic periods like stagflation can make things unpredictable, especially for small businesses, staying prepared is key so your business doesn’t suffer. This means cutting costs where needed and staying on top of your balance sheet.
Small business accounting software like QuickBooks Online can make it easy for you to track expenses, stay on top of invoices, and keep your books up to date so your business can weather economic storms.
Start your free 30-day trial today!