Stagflation, or recession-inflation, is an economic phenomenon marked by persistent high inflation, high unemployment, and stagnant demand in a country's economy. During a particularly severe period of economic conditions in the 1970s, rising inflation and slumping employment put a damper on economic growth in the United Kingdom and seven other major market economies, and investors in equity markets suffered greatly as a result.
Key Takeaways
- Stagflation is an economic phenomenon marked by persistent high inflation, high unemployment, and stagnant demand in a country's economy.
- If your portfolio has more aggressive investments or is not diversified, and it appears as if the economy is approaching a period of stagflation, it may be time to decrease your risk.
- Stagflation may be a reason to delay making large purchases, such as buying a home, especially if the area where you live is experiencing a real estate bubble.
- A sound, a long-term financial plan is the best way to protect your finances from stagflation; If you have been living within your means, stagflation should have no major impact on the way you live your life.
After Iain Macleod, a British Conservative Party politician, used the term stagflation during a speech to Parliament in 1965, it was adopted by the media who began using it when referring to the economic conditions that were impacted the country from 1973 to 1982. The term stagflation is a portmanteau of the words stagnation and inflation. Since then, economists have studied what factors lead to stagflation and developed methods for measuring it. Their findings also include practical suggestions for how investors can protect their finances during periods of stagflation.
How Is Stagflation Measured?
Stagflation isn't measured by a single data point, but rather by examining the direction of a variety of indicators over an extended period of time. Rising prices and rising unemployment are two of these data points. The direction of a single one of these indicators does not necessarily indicate the potential for, or the presence of, stagflation. Rather, the phenomena are considered in aggregate.
Increase in the Cost of Goods and Services
An increase in the cost of food, energy or other individual items is generally not perceived as a sign of stagflation. However, a broad-based rise in the cost of goods and services can be an indicator. Investors who want to anticipate these increases can monitor trends in the Producer Price Index (PPI) and the Consumer Price Index (CPI).
The PPI measures the average change in selling prices received by domestic producers of goods and services over time. From an investment analysis perspective, it is very useful for analyzing potential sales and earnings trends in a variety of industries. From an economic analysis standpoint, movements in the PPI show whether the cost of producing goods is rising or falling.
The CPI measures the weighted average of prices of a basket of consumer goods and services. When tracked over time, the CPI provides insights into the direction consumer prices are headed. The CPI is often referred to as "headline inflation." A normal rise in the CPI is less than 2% per year.When that number rises beyond that, investors begin to fear inflation.
Price increases aren't the only rising indicator that suggests the possibility of stagflation. A rising unemployment rate is another indicator.
A decline in the gross domestic product (GDP) and productivity are both indicators of an ailing economy. GDP tracks the monetary value of all the finished goods and services produced within a country's borders in a specific time period. In a healthy economy, this number is generally rising. Productivity is an economic measure of output per unit of input. Inputs include labor and capital, while the output is typically measured in revenue and other GDP components, including business inventories.
Productivity measures may be examined collectively across the whole economy, or they may be viewed individually by industry to examine trends in labor growth, wage levels, and technological improvement. Declining productivity is generally a sign of an ailing economy.
Why Does Stagflation Occur?
There are multiple theories about why stagflation occurs put forth by Keynesian, monetarist and supply-side economists.
Keynesian economists blame supply shocks for causing stagflation. For example, they cite surging energy costs or food costs as the root cause of the economic problems of stagflation. Monetarist economists cite too rapid growth in the money supply for creating a situation where there are too many dollars chasing too few goods. Supply-side economists blame high taxes, excessive regulation of businesses, and a persistent welfare state that enables people to survive without working. Additional theories exist that stagflation is simply a natural part of the business cycle in modern economies or that politics or social structures are to blame for stagflation.
The failure to forecast, avoid, and contain stagflation once it occurs suggests that the exact forces that create stagflation are not yet known. An effective method of addressing stagflation once it occurs is also unknown. During the 1970s stagflation persisted in the U.S. despite the government's best efforts to quell it. The trend was finally interrupted when the Federal Reserve raised interest rates to the point where borrowing was impossible for many segments of the economy, and the country fell into a deep recession.
How to Protect Your Finances From Stagflation
A sound, a long-term financial plan is the best way to protect your finances from stagflation. If you have been living within your means, stagflation should have no major impact on the way you live your life.
When stagflation does occur, don't panic and sell your stocks and bonds and invest in rare art, gold or other unusual commodities. Stagflation is not a good reason to completely abandon a sound investment strategy. However, if your portfolio has more aggressive investments or is not well-diversified, it may be time to decrease your risk.
Stagflation may also be a reason to delay making large purchases, such as buying a home, especially if the area where you live is experiencing a real estate bubble. However, if you are employed and have money to spend, you should continue making regular purchases. You should also continue your saving and investing habits.
FAQs
A portmanteau formed from “stagnation” and “inflation”, stagflation is an economic hair-raiser. Though it doesn't happen often, we should know what it is and what effects it can have. “Stagflation” is a combination of high inflation and economic stagnation. Inflation drives prices up but purchasing power down.
What is the best explanation of stagflation? ›
Stagflation is the simultaneous appearance in an economy of slow growth, high unemployment, and rising prices. Once thought by economists to be impossible, stagflation has occurred repeatedly in the developed world since the 1970s.
What is an example of stagflation in real life? ›
For example, if there's a sudden, unexpected increase in the price of a commodity like oil, prices surge accordingly while profits drop. The conflict between increased prices and reduced profits leads to a stagflation situation.
What are the main causes of stagflation? ›
Stagflation is an economic condition that's caused by a combination of slow economic growth, high unemployment, and rising prices. Stagflation occurred in the 1970s as a result of monetary and fiscal policies and an oil embargo.
What happens to your money during stagflation? ›
However, during a period of stagflation, companies pull back from growth, and the promise of the purchasing power of bonds declines. Cash and equivalent investments likewise lose purchasing power as consumer prices rise. If you have an IRA or 401(k), you are likewise at risk of losing out.
What assets do best in stagflation? ›
Historical data from previous periods of stagflation show us that gold, energy stocks, agricultural stocks, and real estate, in particular, are the top performers during stagflation.
How do you survive stagflation? ›
Investing in bonds and credit is a good way to protect your investment portfolio against stagflation, high inflation, a recession, and market volatility. For example, floating-rate bonds adjust their interest rates with the change in the CPI (Consumer Price Index) - providing higher inflation protection.
Does real estate do well in stagflation? ›
However, during periods of stagflation, real estate returned 5.5% in real terms while equities returned 2.5% and government bonds -7.3%. In our view, the biggest threats to real estate markets are periods of recession combined with inflation at average or below average levels.
When was the last time the US had stagflation? ›
Stagflation in the 1970s combined high inflation with uneven economic growth. High budget deficits, lower interest rates, the oil embargo, and the collapse of managed currency rates contributed to stagflation. Under Federal Reserve Board Chair, Paul Volcker, the prime lending rate was above 21% to reduce inflation.
Has the US experienced stagflation? ›
High unemployment, slow economic growth and hot inflation are all characteristics of stagflation, a phenomenon that ravaged the U.S. economy in the 1970s and early 1980s.
Is it possible to avoid stagflation? Avoiding stagflation is difficult, because financial regulators have to balance two competing interests: inflation and unemployment. Dealing with inflation usually involves hiking interest rates, making it more expensive to borrow money.
Which event is most likely to cause stagflation? ›
Economists often point to supply chain issues—specifically supply chain shocks—as drivers of stagflation. Supply chain shocks are when an event—like a pandemic or war—causes a sudden change in the supply of certain products or services.
Why is stagflation bad for everyone? ›
Stagflation amounts to a killer combination and can result in an economic downturn in which bills and the cost of living keep rising. These types of economic crises are often caused by big supply shocks and easy monetary policy and last longer than regular recessions because there's no definitive cure.
Should you hold cash during stagflation? ›
Foreign bonds may do better than domestic bonds when stagflation sets in. Cash and cash equivalents. Cash and cash equivalent investments face the same problem as bonds during periods of stagflation. The returns they generate may not be enough to keep up with rising consumer prices, siphoning away purchasing power.
How many years does stagflation take? ›
Between 1965 and 1982, the U.S. experienced its first stagflation dubbed “The Great Inflation.” In the early 1960s, fiscal and monetary policies stimulated growth in employment by keeping interest rates moderately high.
Do stocks go up during stagflation? ›
Both stocks and bonds tend to underperform when stagflation occurs, says Jim Masturzo, CIO of MultiAsset Strategies at Research Affiliates. Stocks are hampered by slow economic growth while high inflation erodes bond returns.
Who wins stagflation? ›
According to research by the World Gold Council, the winners during periods of stagflation between 1973 and 2021 were “defensive assets and real assets, in particular gold, while equities have suffered the most followed by a mixed performance from fixed income.” Remember that analysts may be wrong.
What stock to buy during stagflation? ›
Here are seven of the best stagflation stocks to buy, according to experts:
- Costco Wholesale Corp. (ticker: COST)
- NextEra Energy Inc. (NEE)
- Crown Castle Inc. (CCI)
- Pfizer Inc. (PFE)
- TJX Cos. Inc. (TJX)
- Barrick Gold Corp. (GOLD)
- Apple Inc. (AAPL)
It is believed that during stagflation, investors tend to turn to gold as a safe haven asset as the economic and financial conditions are uncertain. Additionally, gold is seen as a hedge against inflation, as its value is not tied to any currency or government.
How did we cure stagflation in the 1970s? ›
Unemployment rates rose, while a combination of price increases and wage stagnation led to a period of economic doldrums known as stagflation. President Nixon tried to alleviate these problems by devaluing the dollar and declaring wage- and price-freezes.
In the 1970s, part of the stagflation was caused by rising wages (powerful trade unions). A policy tried was wage control – government intervention to limit wage rises. In theory, limiting wage increases can break the cycle of wage inflation and help to improve the economic situation.
Which is worse stagflation or recession? ›
Stagflation is a situation where the economy is not growing, but prices are rising, and there is high unemployment. Stagflation is generally considered worse than a recession because it is a much more challenging economic condition to manage.
Does raising interest rates help stagflation? ›
Poor monetary policies
Stagflation is a real problem for policy makers because the Central Bank can increase interest rates to reduce inflation or cut interest rates to reduce unemployment. It cannot, however, do both at the same time.
What president had the highest inflation rate? ›
Jimmy Carter (1977-1981)
His presidency had by far the highest GDP growth, more than 1% higher than President Joe Biden thus far. But he also had the highest inflation rate and the third-highest unemployment rate.
What president was known for stagflation? ›
Carter took office during a period of "stagflation," as the economy experienced a combination of high inflation and slow economic growth. His budgetary policies centered on taming inflation by reducing deficits and government spending.
What was the worst inflation in US history? ›
United States: 1917
The highest figure was in 1776, when the rate of inflation was 29.78%. But, that was more than 100 years before the CPI (consumer price index) was introduced. Since its inception, the highest inflation rate ever recorded in the United States was 20.49% in 1917.
Is stagflation coming in 2023? ›
Our Research analysts see a challenging new phase for the world economy in 2023: slowing growth and lingering inflation, also known as stagflation.
What assets performed well in the 1970s? ›
Gold was the best-performing asset in the 1970s, spiking more than 22%. Other commodities, such as energy and raw materials, also outperformed, rising 15%.
What comes after stagflation? ›
Hyperinflation is a period of fast-rising inflation; stagflation is a period of spiking inflation plus slow economic growth and high unemployment. Deflation is when prices drop significantly, due to too large a money supply or a slump in consumer spending; lower costs mean companies earn less and may institute layoffs.
Are we headed for a financial collapse? ›
Gross Domestic Product (GDP)
The report sets overall 2022 U.S. economic growth at 2.6%, which makes it pretty clear that the U.S. was not in a recession in 2022. However, Bill Adams, chief economist for Comerica Bank, believes that GDP will likely slow sharply in early 2023.
Nixon issued Executive Order 11615 (pursuant to the Economic Stabilization Act of 1970), imposing a 90-day freeze on wages and prices in order to counter inflation.
Who suffers during stagflation? ›
Rising prices put a major squeeze on the unemployed or those living on a tight budget. As the unemployment rate rises along with prices, people are forced to go into their savings more often. As consumer spending slows, business revenues decline, with business-to-business (B2B) companies also suffering.
How do you respond to stagflation? ›
Solutions to stagflation
Monetary policy can generally try to reduce inflation (higher interest rates) or increase economic growth (cut interest rates). Monetary policy cannot solve both inflation and recession at the same time.
What is the downside of holding too much cash? ›
Excess cash has 3 negative impacts:
It lowers your return on assets. It increases your cost of capital. It increases overall risk by destroying business value and can create an overly confident management team.
What is the best thing to do during high inflation hold your wealth in cash? ›
The best option for keeping up your personal finances when inflation rises is to keep a percentage of your money in long-term investments as part of a diversified portfolio. Retirement accounts, for example, are commonly used as a way to grow your money slowly over time and keep up with the natural rise of inflation.
Is cash king during the recession? ›
The phrase means that having liquid funds available can be vital because of the flexibility it provides during a crisis.
How long will 2023 recession last? ›
In a best-case scenario, the U.S. will likely see a 'soft landing' with low/slow growth across 2023 before picking up in 2024. However, a downside scenario is a real possibility and could see the U.S. enter a prolonged recession lasting well into 2024, as is currently forecast for the UK and Germany.
What is the economy prediction for 2023? ›
Advanced economies are expected to see an especially pronounced growth slowdown, from 2.7 percent in 2022 to 1.3 percent in 2023. In a plausible alternative scenario with further financial sector stress, global growth declines to about 2.5 percent in 2023 with advanced economy growth falling below 1 percent.
Does stagflation precede a recession? ›
Does stagflation mean recession? No, but periods of recession can occur during a multiyear stretch of stagflation. Stagflation is a combination of stagnant economic growth together with high unemployment and high inflation.
Which best describes stagflation quizlet? ›
Which of the following best describes stagflation? A period of high inflation and high unemployment.
Stagflation is best described as. decreasing output and increasing prices. Government debt is a flow variable; the budget deficit is a stock variable.
What is the definition of stagflation quizlet? ›
stagflation. A period of slow economic growth and high unemployment (stagnation) while prices rise (inflation)
What is a stagflation quizlet? ›
Stagflation is a situation of both high inflation and high unemployment; occurs when output is falling at the same time that prices are rising.
Which one of the following is most likely to cause stagflation? ›
Explanation: From the given scenarios, stagflation is caused by a rise in oil prices because increased oil prices will increase the cost of production as oil is the input resource for the production of various goods.
Does stagflation lead to recession? ›
Generally, a recession occurs when an economy shrinks or contracts and inflation rates are low. In contrast, stagflation occurs similarly to a recession, but inflation rates are high for a prolonged period. In the latter case, growth can be hindered and recovery can take years.
Is stagflation a recession or inflation? ›
Stagflation is a situation where the economy is not growing, but prices are rising, and there is high unemployment. Stagflation is generally considered worse than a recession because it is a much more challenging economic condition to manage.
Is stagflation good or bad for the economy? ›
Stagflation is a stagnant economy combined with high inflation. Stagflation amounts to a killer combination and can result in an economic downturn in which bills and the cost of living keep rising.
