Summary
Doubts are now being raised in different circles of a possible period of stagflation being induced as a result of Federal Reserve monetary policy. While I do not think the present conditions point towards stagflation and we are presently a long way from reaching any such point, yet in the present context I think it would be advisable to look at the effects on accounting and financial reporting of any such economic situation for a sustained period of time.
Analysis
1. The first and foremost effect to my mind of a period of stagflation is a sustained decline in productivity and output alongwith an increase in prices.
2. Ever since the subprime crisis broke out - was initially not recognized as a problem - and then there were insufficient reactions - the problem has become compounded. It is as if in a situation of war the correct resources are initially not given to the field commanders and then whatever is given is just not enough. The Fed has apparently been trying to find the right balance - a tricky situation for which trained central bankers are supposed to have the right tricks up their sleeves at any point in time.
3. What matters to me in this analysis however is what will be the effects of stagflation on corporate results and securities valuation. I look upon these aspects in limited detail in the following paragraphs.
4. The first point to consider is that there is no affirmative accounting guidance available for a period of stagflation. Even for inflationary situations the position under IFRS (IAS 29) and US GAAP (SFAS 89) as amended only gives non mandatory guidance in this respect. The standards to say the least have hardly been discussed or elaborated upon since the hyperinflation of the 70's has not been seen in major economies at anytime since then.
5. The obvious effect of this would be that analysts would flounder in trying to adjust accounting statements over a time frame of say 4-5 years in terms of current cost.
6. Further since most financial statements do not give extensive segment or quantitative disclosures the problem would become more acute in a period of rising prices and declining productivity. This is because increased profits would not necessarily translate into increased wealth for the stakeholders and investors in the company.
