The oil price shocks of the 1970s provided what would become a textbook example of how stagflation can emerge. After OPEC imposed an oil embargo in 1973, energy costs surged, increasing production and transportation expenses across the economy. Companies faced with higher costs had to either reduce output (leading to layoffs) or raise prices (feeding inflation), and many did both. The result was a toxic combination of rising unemployment and accelerating inflation that persisted throughout the decade. These supply shocks followed an accommodating monetary policy by the Federal Reserve, aimed at stimulating economic growth.
During a period of stagflation, however, prices continue to rise while the economy stays the same or even contracts. Those supply shocks followed a period of accommodative monetary policy in which the Federal Reserve grew the money supply to encourage economic growth. Meanwhile, global economic growth slowed sharply in the 1970s—a decade marked by two different recessions in the U.S. and the lead-up to a third one that began in 1980. Federal Reserve Chair Paul Volcker guided the Fed through a vice-like tightening of monetary policy, raising interest rates dramatically (the federal funds rate peaked at almost 21% in 1981), to break the inflationary spiral. However, these policies helped spark two recessions in the early 1980s, with the unemployment rate reaching 10.8% in 1982. The episode changed how the Fed and other central banks dealt with inflation, namely by seeing it and thus the specter of stagflation as having priority in their efforts over employment.
It’s also a conundrum for fiscal and monetary policymakers, as it turns the Phillips curve on its head. Although the U.S. eventually overcame the stagflation scourge of the 1970s—after a decade of economic doldrums—the causes of stagflation and the best solution for overcoming it remain a matter of debate. In its June 2022 global economic forecast, the World Bank warned that the risk of stagflation has risen due to a “sharp slowdown” in global economic growth coinciding with a “steep” rise in the rate of inflation to multi-decade highs. The 1970s also had some shocks that affected expectations about how the economy would be in the future. The new system of flexible exchange rates eventually affected prices, as did the oil price shocks of the 1970s, when energy prices rose rapidly. Unemployment denotes the number of individuals actively searching for employment but encountering difficulty in securing jobs.
What is stagflation?
Due to the fall in the short-run aggregate supply curve from SRAS0 to SRAS1, the new equilibrium is now at E1. There is an increase in the general price level from PL0 to P1 (inflation). There is also a fall in the real GDP from Y0 to Y1, leading to unemployment and negative economic growth. If you want more tactical advice, consider overweighting defensive stocks in sectors such as consumer staples, utilities, energy and healthcare, Brochin says. Businesses in these sectors tend to have more stable earnings, which can provide some protection against stagnant economic growth and inflation.
High inflation often happens when a central bank loosens its monetary policy, making borrowing money cheaper and increasing the cash supply in the economy. Growth typically means more jobs and higher wages, which in turn boosts economic expansion. The flip side is that with more money in the economy and in consumers’ pockets, prices can also rise, causing higher inflation. Unlike some periods of inflation, stagflation is when there are rising prices but no economic growth.
For investors, traditional safe-haven assets like bonds may struggle as rising interest rates erode their value. Treasury bonds, while potentially benefiting from falling rates, are negatively impacted by rising inflation, which erodes income and puts pressure on yields. Historically, equities also struggled during stagflation, with returns often turning negative as companies face falling revenues and rising costs. These factors can contribute to a slowdown in global economic growth, potentially leading to a prolonged period of economic stagnation across multiple regions. One of the most daunting aspects of stagflation is the dilemma it presents for Federal Reserve policy makers. Usually, if economic growth is too slow, Fed officials can lower interest rates to stimulate activity.
Why are some people concerned about stagflation now?
During stagflation, consumers face the double burden of high prices and weak economic growth, eroding their purchasing power. Monetarists argued that the policy mistakes of the Keynesians in government led to stagflation in the 1970s. They argue that central banks kept interest rates too low for too long as inflation was rising, inadvertently fueling an inflationary spiral. This created a situation where the public began to expect continued inflation, leading to preemptive price increases and hindering long-term investment.
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High inflation is fairly easy to understand as it’s nearly impossible to ignore. Anytime you drive by a gas station with its prices listed, you’ll be reminded of the impacts of inflation. “Stagflation, in that sense, is more impactful on portfolios than a one-off crisis.” The 1970s are known for many things, but the one economists are most likely to recall is stagflation, the combination of high inflation and unemployment that can cripple an economy and investor portfolios.
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The economic outlook has become more clouded in the last few months, at least for the intermediate term. This is due primarily to the Trump administration’s implementation of tariffs and proposal for more tariffs. The scenario still remains a risk, Sløk said, adding that the effects of Trump’s Liberation Day tariffs were “still working their way through the trade pipeline.” The jobless rate in the US will keep picking up through at least the next 18 months. Apollo estimates that unemployment could rise from 4.2% currently to 4.4% in 2025 and tick up to 5% or higher in 2026.
Such an energy transition also has the additional, much-needed benefit making the economy and society as a whole more sustainable. The Federal Reserve could increase the Federal funds rate to try and rein in high inflation. This could increase the cost of borrowing, which would immediately affect credit card interest rates and could influence interest rates on mortgages, auto loans, and student loans. But keep in mind that the Federal Reserve has the dual responsibility of regulating inflation and unemployment. High unemployment with high inflation may make it a difficult decision for the Fed to raise rates and possibly worsen unemployment. Eager to soothe worried investors, businesses and consumers, the Fed urged caution about getting too worked up about its forecast, noting that inflation caused by tariffs may not be long lasting.
- Building on Bekaert, Engstrom, and Ermolov (2025), the model integrates survey forecasts, structural shock decomposition, and a non-Gaussian BEGE-GARCH approach to capture time-varying volatility and skewness.
- First named in the 1960s, stagflation shattered long-held economic theories when it emerged most dramatically during the 1970s oil crisis.
- “If anything is going to derail markets today, it will overwhelmingly be stagflation.”
- There was a big process of globalization in the intervening decades that made the economy more interdependent with the rest of the world.
- Additionally, US gross domestic product, Fed officials predict, will grow at an annual rate of 1.7%.
Central banks ease monetary conditions when the economy is heading toward recession. They can’t do that when inflation is high, however, and that’s potentially worrying. A recession is generally said to be in motion when there have been two consecutive quarters of negative economic growth. Supply-side policies can increase productivity in order to facilitate higher levels of growth, while the risk of high inflation remains low.
With this, we see a decrease in job openings, layoffs and rising unemployment rates. Explanations for the shift of the Phillips curve were initially provided by the monetarist economist Milton Friedman, and also by Edmund Phelps. Both argued that when workers and firms expect more inflation, the Phillips top 10 best brokers with high paying forex affiliate programs curve shifts up (meaning that more inflation occurs at any given level of unemployment). While this idea was a criticism of early Keynesian theories, it was gradually accepted by most Keynesians, and has been incorporated into New Keynesian economic models. Stagflation serves as a reminder that the economy is a dynamic and intricate system, where cause-and-effect relationships are not always straightforward.
- For instance, if monetary policy is too loose for an extended period, it may lead to excessive money supply growth.
- Unfavorable demographic trends caused by an aging population that leaves fewer people in the workforce alongside increased taxes and regulations could cause economic growth to stagnate, Rosen says.
- But stagflation never arrived, and McMillan isn’t worried about another episode happening any time soon.
- Certain sections of this blog may contain forward-looking statements that are based on our reasonable expectations, estimates, projections and assumptions.
- Keynes detailed the relationship between German government deficits and inflation.
These are firms with strong brands, unique technologies, or essential services that allow them to effectively pass on their increased operating costs to consumers without significant loss of demand. Such companies are often found in defensive sectors like consumer staples, utilities, and healthcare, as well as some resilient technology sectors. Commodities, such as crude oil, industrial metals, and agricultural products, also gain appeal. This is partly because supply-side shocks, which can contribute to stagflation, often directly cause an increase in commodity prices. Real estate, particularly where rents can be adjusted to reflect inflation, can offer a degree of inflation protection. However, a rising interest rate environment can exert downward pressure on property values.
After the mid-twentieth century, and particularly during the 1960s and 1970s, stagflation gained wider recognition as a serious problem. Politician Iain Macleod in the 1960s, during a speech in the House of Commons. He was describing the United Kingdom’s “stagnation situation,” in which there was a combination of stagnation and inflation. The commodities industry can be significantly affected by commodity prices, world events, import controls, worldwide competition, government regulations, and economic conditions. Although stagflation may not cut your salary outright, high inflation may reduce your purchasing power.