Combat Stagflation By Increasing Productivity

Stagflation is characterised by stagnating economic growth and high unemployment while simultaneously experiencing high inflation rates. This phenomenon was considered an impossibility until it was first conceptualised in 1965. Higher unemployment would typically indicate lower spending by households, and therefore a slowdown in inflation. However, since 1970, the world has seen multiple cases of stagflation.

Stagflation is particularly difficult to handle for monetary policymakers, as attempting to correct one factor may exacerbate the other. The UK has recently been facing stagflation, with economic growth slowing (or even decreasing) as inflation rates continue to rise.

The key tool used to combat stagflation is interest rates as a part of monetary policy, where the primary function of monetary policy is to achieve price stability. In a general sense, increasing interest rates should encourage households and businesses to save more and spend less, thus creating disinflation. However, a reduction in household spending and higher costs for businesses would typically compound higher unemployment rates. It is a tricky balancing act for central banks.

For businesses that are seeking to raise debt, higher interest rates mean higher costs for borrowing, making it more challenging to achieve plans for growth. At these times, it is vitally important to manage costs and consider a variety of financial instruments and transaction structures to enable growth.

The generally accepted method to best combat stagflation is to increase productivity. Greater productivity should generate growth while avoiding an impact on prices. This approach can be taken by businesses at a micro level. As the UK continues to grapple with challenges associated with high inflation and the cost of living, it will be important for policymakers to strike a delicate balance between managing inflation and promoting economic growth. It is important for businesses to have a firm understanding of the effects policy changes will have.