Stagflation vs recession: What's the difference? Which is worse?
- Stagflation and recession are words we're hearing a lot.
- But what do they mean, what are the odds, and which is worse? Should I worry?
- Both are bad, but there are steps to consumers can take now to mitigate the pain.
Stagflation and recession are increasingly being used to describe where the economy might be headed. The World Bank warned on Tuesday that global economies were at risk of stagflation, if not recession.
“The world economy is again in danger,” David Malpass, president of the World Bank, said in the latest edition of the Global Economic Prospects report. “It is facing high inflation and slow growth at the same time. Even if a global recession is averted, the pain of stagflation could persist for several years – unless major supply increases are set in motion.”
Both scenarios are dour, but are either of these inevitable or is there still a pathway around them?
And if we had to face one, which one would be less painful?
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What’s the difference between stagflation and recession?
A recession is generally accepted as at least two consecutive quarters of negative economic growth, which naturally leads to rising unemployment. But inflation usually remains mild, allowing the Federal Reserve to cut its benchmark funds rate to jumpstart the economy.
Lower rates reduce borrowing costs, which encourages spending. The opposite normally also holds – if the economy overheats and inflation starts to rise, higher rates should slow borrowing, restrain growth, and cool inflation.
Stagflation, though, is vague. Growth doesn’t have to be negative. It can just be “stagnant,” or low, but it’s always accompanied by “high” inflation and “high” unemployment. But what is considered “high” and “low”?
There aren’t any clear demarcation lines, but for John Leer, chief economist at research firm Morning Consult, stagflation means “essentially flat or contractionary” growth with inflation above 5%.
Mark Zandi, Moody’s Analytics chief economist, added an unemployment rate of at least 5%.
What are the odds of stagflation?
So far only a handful of economists – including former Treasury Secretary Lawrence Summers - think stagflation is nearly inevitable.
Here’s the problem: the Fed must raise rates aggressively to dampen inflation in an already slowing economy. Steep rate increases will slow the economy even more. Chances are the Fed can't substantially cut inflation before the economy grinds to a halt from rate hikes, they say.
Most economists believed the Fed could avoid stagflation, especially after consumer prices eased off a 40-year high in April. However, with the surprise jump in May back to a four-decade high, the Fed may be losing this race.
“Eventually, output almost has to stagnate,” said Chester Spatt, finance professor at Carnegie Mellon University's Tepper School of Business. He puts stagflation odds around 60% to 70%.
“The danger of stagflation is considerable,” Malpass said, noting “it’s a phenomenon—stagflation—that the world has not seen since the 1970s.”
What are the odds of a recession?
Unlike stagflation, most economists see some chance of recession. However, the odds range from slim to highly likely.
Goldman Sachs sees a 15% chance over the next year but a 35% chance over two years. “We believe fears of declining economic activity this year will prove overblown unless new negative shocks materialize," Goldman Sachs Chief Economist Jan Hatzius wrote in late May.
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In contrast, Deutsche Bank’s recent survey of more than 560 market participants worldwide showed that 78% of respondents expected a recession by the end of 2023, up from 61% in April’s survey and 31% in February. Most of them (69%) think the only way the Fed can tame inflation is via a recession.
Notably, as much as respondents believe only a recession can push inflation back to the Fed’s 2% target, 39% think the Fed will lose its nerve and end up tolerating above-target inflation to avoid one.
Is stagflation or recession worse for consumers?
Both are bad, but there’s one big difference: stagflation pain is worse and lasts longer.
“Both should be viewed in the impact on joblessness,” Joe Carson, Former Chief Economist at Alliance Bernstein, said. “Recession triggers a sharper rise in the short run whereas stagflation triggers a more permanent increase in joblessness.”
Diane Swonk, Grant Thornton chief economist, forecasts the unemployment rate will have to rise above 5%, from May’s 3.6%, to tame inflation.
A recession is a normal part of an economic cycle and is painful as the economy slows and unemployment rises. But it historically lasts a year or so and isn't marked by inflated prices for everything.
Stagflation is prolonged slow economic growth, with ongoing layoffs and high inflation. With high unemployment, consumers already have less money to spend. Add inflation and what money they have is worth less each day.
How to prepare for stagflation or recession?
The first thing is to shore up your finances. With the Fed determined to raise interest rates until inflation abates, anyone with variable-rate debt should consider converting it to a fixed-rate loan to avoid increasing payments as soon as possible.
Consumers also should also try to pay off as much credit card debt as possible. Credit cards already notoriously carry high interest rates, and those rates are likely only going even higher.
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If there’s money left, consider investing in what people need, no matter what the economic landscape. That includes commodities like precious metals, industrial metals, energy products, and other industrial and agricultural goods.
In stocks, the same idea holds but make sure the companies have strong financials and their stock prices aren’t too expensive relative to earnings and cash flow. In other words, look for value. Dividends are a bonus because you’ll be able to earn income on the side.
What about the housing market?
Now the economy is slowing, and interest rates are rising. Some may be worried about whether another housing crash like the one in 2008 that contributed to the Great Recession is in the cards.
Leer said. “There will be some people who are facing pretty severe difficulty with housing payments but more broadly, the reforms we made have resulted in a more capitalized finance system and debt repayments are more reasonable. There’s a greater share with outstanding mortgages that have fixed rates than in 2008.”
In the run-up to the 2008 housing crisis, approximately 80% of U.S. subprime mortgages issued in those years were adjustable-rate mortgages, according to a Duke University report.
“We could see a correction, but it will likely be much milder,” said Leer.
Medora Lee is a money, markets, and personal finance reporter at USA TODAY. You can reach her at email@example.com and subscribe to our free Daily Money newsletter for personal finance tips and business news every Monday through Friday morning.