What is Stagflation and How Can Small Business Owners Manage It?

August 19, 2022

The last three years have seen their share of economic hardship. Unfortunately, successfully managing the pandemic doesn't mean an untroubled period of growth and prosperity. High inflation and a softening economy have opened the door to one of the most frightening economic threats: stagflation.

This combination of steeply rising prices and sluggish economic activity hasn't happened in more than 40 years. As such, few small business owners have practical experience navigating times like these. Here, we'll let you know what stagflation means for small businesses and provide steps you can take to prepare your startup for this potential economic crisis.

What is stagflation?

To understand stagflation and its risks, first consider a few basic terms:

  • Inflation: This refers to the speed at which prices rise. A little inflation is seen as healthy (experts usually target 2% under normal circumstances). But extreme rates can impact economic decision-making and create dramatic market dislocation.

  • Recession: If a country's economy shrinks over a prolonged period of time, that situation is considered a recession.

  • Stagnation: Here, economic activity hasn't slipped into a recession but it remains sluggish. Growth sits near the zero mark, typically leading to elevated unemployment and weak economic activity.

Generally speaking, the people who manage the U.S. economy, like policymakers within the Federal Reserve, worry about two major threats: inflation and recession. Usually, these risks counteract each other &#151 you don't frequently see them happen at the same time.

Under normal circumstances, if an economy gets too strong, inflation becomes a significant danger. However, in that case, policymakers don't need to worry much about a recession. Meanwhile, times of economic contraction customarily don't have enough activity to generate higher prices. With demand low, inflation becomes less of a danger.

Occasionally, however, circumstances conspire to see inflation and stagnation happen simultaneously. That brings up the dreaded threat of stagflation.

Why is stagflation a concern for small business owners now?

The term stagflation dates back to the mid-1960s. However, the 1970s became the era most commonly associated with these economic doldrums. A series of fuel shocks, the lingering impact of aggressive spending on social programs and the Vietnam War, and a slowing economy led to a period of time sometimes referred to as the "Malaise Era."

This represented the height of stagflation in the U.S. Now, there are concerns that the country could be slipping back into a similar situation.

As part of this, the latest reading for consumer inflation showed that prices in June rose more than 9% compared to the previous year. This represented the highest inflation rate in more than four decades &#151 since 1981.

That's the inflation part. Unfortunately, the economy has shown significant signs of weakness as well. Government data showed that GDP shrank in the second quarter, following a similar period of retraction in the first three months of the year.

With labor markets still relatively strong, many have been reluctant to call the latest downturn a full-blown recession yet. But whatever the technical designation, the economy has been stymied recently. Combined with the continuing advance in prices, the stage has been set for possible stagflation.

The economy has been stymied recently. Combined with the continuing advance in prices, the stage has been set for possible stagflation.

How will small businesses be affected by stagflation?

Yes, stagflation means facing two of the biggest economic challenges at the same time. But what does this mean specifically for small businesses? Here are three of the major impacts you'll likely see:

Higher Expenses

The inflation part of the equation leads to higher costs. In some cases, you might be able to offset this with higher prices for your products and services. However, the mixture here will depend on your particular market. Either way, you'll need to consider increased expenses for things like materials, labor, and energy.

Lower Consumer Spending

Higher inflation cuts into discretionary spending for consumers. As basic items (food, energy, etc.) get more expensive, people need to cut back in other areas. A similar dynamic impacts businesses as well, as they scramble to deal with a jump in basic costs. Meanwhile, this situation is made even more complicated by the current supply chain tangles.

Beyond the higher prices, stagflation comes with the added challenge of slow economic activity. That further cuts into spending ability, as consumers and businesses face a tighter environment.

Harder to Obtain Funding

Finding loans and other sources of capital gets difficult in a stagflationary environment. With interest rates rising, the easy money of the last several years has likely disappeared. As such, small businesses will have a tough time finding financing, given the spike in the cost of borrowing and increasing risk aversion among lenders.

How to prepare for stagflation (and how to handle it if it comes)

There’s still a chance the economy will avoid a long period of stagflation. Still, you can’t run your business on hope. Given the economic storm clouds ahead, you need to prepare. Here are some steps you can take:

Control Costs

You can’t control inflation. However, there are parts of your operation you can still command. Leverage these as much as you can. Look for ways to tamp down spending. At the same time, focus on your core requirements and eliminate any excess or unnecessary spending.

Maximize Productivity

In boom times, you can afford a little sloppiness in your operations. However, stagflationary situations require the leanest organization possible. Search for ways to get things done more efficiently. This will protect your margins, even as costs rise and demand lags.

Steady Your Balance Sheet

Remember when we talked about more restrictive capital markets? Here, you'll need to take these limitations seriously.

Given the market environment, you can't count on additional cash coming into your startup. You'll need to take a close look at your balance sheet, making sure you have adequate resources to weather the economic storm. As part of this, avoid debt and preserve cash as much as possible.

Focus on Profitable Businesses

The world's biggest companies are gearing up for a difficult economic time by making targeted cutbacks. Last year, Meta announced $10 billion a year in spending on the metaverse. Now, the company is thinking about job cuts in the face of a more complicated economic environment. Similar news has come out of the likes of Microsoft, Apple, and Amazon.

This strategy doesn't just work for the behemoths of technology and commerce. It might just save your startup as well.

A stagflationary environment means limiting your bets. With funding hard to come by and costs rising, you need to focus your resources on only the most promising opportunities. This might force you to rethink your expansion plans, concentrating your attention on your most profitable endeavors.

A stagflationary environment means limiting your bets. With funding hard to come by and costs rising, you need to focus your resources on only the most promising opportunities.

Target Your Growth Efforts

Stagflation includes the concept of stagnation. However, while this is gripping the overall economy, you don't want it to happen to your business. Even during tough economic times, you want to seek out ways to build. This way, you'll be well positioned when the economy turns your way.

That said, a stagflationary environment favors disciplined companies. This is not the time to take wild fliers on new products or gamble with your limited resources. Instead, rigorously review the market and pinpoint the safest avenues to push forward.

Getting ready for potential stagflation

Running a small business requires a high degree of adaptability. Knowing how to modify your processes to handle economic crises could be the difference between success and failure.

With inflation rising and the economy weakening, the coming era will likely test this ability for every entrepreneur. Use the information provided here to help you prepare for a combination of challenges that hasn't occurred in more than four decades. With the right preparation and a well-conceived game plan, you can combat the possible upcoming period of stagflation.