- Stagflation is a combination of economic stagnation and high inflation.
- It’s a tricky situation that can cause problems for consumers and businesses.
Anyone who’s been grocery shopping or filled their gas tank lately is likely feeling the impact of high inflation. It results in skyrocketing prices and does your bank account absolutely no favors. While high inflation has been getting a lot of attention recently, you may not be as familiar with its close (and nastier) relative, stagflation.
Here’s what you need to know about stagflation, how it’s different from inflation and how it might affect you.
Inside this article
What causes stagflation?
Like periods of high inflation, stagflation is not a good thing. It happens during times of slow economic growth, high unemployment and increasing inflation. It’s a terrible trifecta—or, as Anessa Custovic, chief investment officer at Cardinal Retirement Planning, says, “Stagflation is the perfect storm in economics.”
Experts suggest that supply shocks can be a catalyst for stagflation during an economic slump. A supply shock is a rapid decrease in the supply of an essential commodity, resulting in substantial price increases. (We’re looking at you, ridiculously high oil prices!).
Stagflation vs inflation
Inflation happens when the price of consumer goods increases. In a healthy economy, inflation stays relatively low and doesn’t increase or decrease rapidly. But high inflation periods can result in uncomfortably high prices and lower consumer purchasing power.
Stagflation, on the other hand, happens when high inflation occurs in tandem with low economic growth. Basically, prices get so high that consumer demand decreases, goods become more expensive to produce and unemployment increases. Remember that terrible economic trifecta we mentioned earlier? That’s stagflation. Our in-depth article about Depressions vs Recessions vs Inflation could help you understand more.
Why is stagflation bad?
Periods of stagflation are marked by higher prices and lower economic output. As a result, workers look to their employers for salary increases to help pay the bills. But the problem is that if businesses aren’t growing, they can’t afford to pay their workers more. And if companies are seeing declining profits, they start laying people off. Spending declines further, and companies may take even more steps back to curb losses.
These difficulties lead to long-term economic slumps, which negatively impact both businesses and consumers over the long haul.
Stagflation can be really difficult to fix, which we’ll discuss in a moment.
How can stagflation affect you?
We’re already seeing prices soar for essential goods due to high inflation. This obviously hits us directly, and may have us rethinking our spending habits or even vacation destinations.
As noted, job loss also becomes a real possibility during periods of stagflation. That’s frightening for any one of us. Of course, we’re in an extraordinary moment in which demand for workers is far outstripping supply (related to The Great Resignation). It’s throwing economists for a loop.
"When taken to extremes, stagflation is the worst of possible economic scenarios because consumers face the prospect of losing their jobs and having their paychecks eaten away by inflation,” says Scott Knapp, chief market strategist at CUNA Mutual Group, a financial services company. “Worrying about both at the same time can put extreme stress on households, especially among the poor and middle class.”
How to fix stagflation
Generally, to address high inflation, the Federal Reserve raises interest rates in an effort to slow down the economy.
This can work all right when the economy is healthy. The problem is, in periods of stagflation, the economy is not so healthy, meaning those higher interest rates can further erode economic growth and cause unemployment to spike.
On the flip side, the government typically lowers interest rates to alleviate high unemployment.
The strategies for addressing high inflation, low economic growth and high unemployment are at odds with each other, making stagflation tricky to fix. “This is what makes stagflation particularly scary to people—there is no three-prong approach that can solve all the problems,” Custovic says.
Economists suggest that one way to address stagflation is to stabilize commodity prices. But the solutions for lowering prices on commodities like crude oil and wheat are complicated and may take a long time to implement. The bottom line is that there’s really no easy solution.
Example of stagflation
During the last period of stagflation in the 1970s, the U.S. was grappling with high unemployment and social turbulence due to its ongoing involvement in the Vietnam War.
Consumers were also hurt by historically high oil prices due to the OPEC embargo in 1973, in which oil exports to the U.S. and other countries were halted. Gas prices skyrocketed, causing a domino effect across all U.S. industries—similar to what we’re seeing today as a result of pandemic supply chain issues and the Russian-Ukrainian war. Costs increased across the board, production stagnated and high unemployment rates persisted. Ultimately, the country ended up in a recession that lasted from 1973 to 1975.
While we’re not in a period of stagflation yet, experts are concerned we could be headed that way due to the current economic climate.
“If the economy slows as expected and supply chains remain challenged, stagflation could become a reality in the U.S.” Knapp says. “We’re not there yet, but the probability of stagflation is slowly rising."