What Is Stagflation & Will It Happen Again?

December 17, 2020 · 5 minute read

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What Is Stagflation & Will It Happen Again?

The economic term stagflation is a mashup of the words stagnation and inflation—and it’s worth being aware of because of the threat it poses to economies.

The stagflation definition is simple: it indicates rare periods of time where prices go up, and wages don’t follow. Stagflation creates potentially disastrous conditions where people experiencing a decline in purchasing power also feel discouraged against making investments. It can create a chain reaction of wealth-destroying events where unemployment climbs, and at a macro scale, as economic output slows it contributes to a nationwide economy shrinking.

What Is Stagflation?

Newsweek economic analyst Robert J. Samuelson put it succinctly when he wrote in 2008 : “The co-existence of high (or rising) inflation with high (or rising) unemployment is not an abnormal event.” Samuelson goes on to explain that when “sometimes necessary” recessions (necessary because they typically prevent inflation and the damage it causes) are prolonged and also precipitate inflation, stagflation happens.

While there is no doubt over what causes stagflation, economists and media outlets all over the world have long debated whether stagflation is even possible, or whether stagnation and inflation are in fact mutually exclusive. However, a few key moments in history prove that stagflation is a real event.

Has Stagflation Ever Really Happened?

Stagflation is not just a theoretical concept. The term was coined by British Conservative Party politician Iain Norman Macleod in a 1965 speech to Parliament during a period of simultaneous high inflation and unemployment in the United Kingdom. He said: “We now have the worst of both worlds—not just inflation on the one side or stagnation on the other, but both of them together. We have a sort of ‘stagflation’ situation and history in modern terms is indeed being made.”

Not long after that, during the 1973-1975 recession in the US, the United States experienced five financial quarters where gross domestic product dipped into the negative. That stagflation was part of a larger sequence of events called the Nixon Shock.

This, in a nutshell, is what happened: Responding to increasing inflation in 1971, President Richard Nixon imposed wage and price controls, and also surcharges on imports. The post-World War II economic boom of the ’50s and ’60s was proving unsustainable, and while those measures imposed by Nixon were intended to stabilize the relationship between unemployment and inflation, instead the result was a wage-price spiral where unemployment continued to climb because workers were unwilling to sell their labor for lower wages being offered by employers who were similarly unwilling to increase salaries.

This created a perfect-storm condition where, when then the 1973 oil crisis hit, those surcharges on imports made prices at the pump—and across many US industries— skyrocket to then-record prices. Thus, there was a prolonged recession accompanying the inflation—a stagflation. According to the National Bureau of Economic Research, the inflation rate in the US that decade hit its peak in 1979 at 13.3%—markedly higher than the decade average of 6.85%.

To understand where the economy is today, it’s valuable to understand where it has been in the past. Investors can get a crash course in history by reading a guide reviewing past market contractions, which offers insights into how economists know when a recession is coming and also has some tips on how to prepare for a coming recession. For an even deeper dive into recessions, investors might also want a refresher on what is a recession—including what causes one, its impact, and how it differs from a depression.

Will Stagflation Happen Again?

As the 2020 COVID-19 pandemic has demonstrated, world events are highly unpredictable, nations can be vulnerable to sudden setbacks, and even seemingly strong economies can be abruptly brought to their knees. In a May 2020 Financial Times opinion piece, American economist and senior economics lecturer at Yale University Stephen Roach warns that “a return to 1970s stagflation is only a broken supply chain away.”

Roach suggests that one of the greatest risks for the post-coronavirus world is a possibility for extended inflation to course correct across all the sagging industries and rates the United States has experienced since the coronavirus spread here earlier this year. He goes on to write that, “Soaring deficits and debt could compound the problem. For now, no one is worried about them because of a conviction that interest rates will stay at zero forever. But with fractured supplies set to push inflation higher, that assumption will be tested.”

While no one can predict the future, it stands to reason that events that have happened in the past can happen again. Stagflation is something to be aware of, but not necessarily to be paralyzed by.

What Should Investors Watch For?

In 2018, the American Institute for Economic Research published an article wondering whether stagflation can happen again during this current decade. In it, German economics professor Antony P. Mueller notes that current conditions echo the ones that preceded the Nixon Shock: A sudden, short period of time where inflation shot up together with the unemployment rate.

While the US unemployment rate did shoot up to 14% between March and June 2020 during the pandemic, as of October it had declined to 7.9%. While that is an encouraging trend, Mueller notes in his 2018 piece that the ’70s stagflation occurred after a time lag. Following that logic, it’s possible that if banks and fiscal policies mismanage the recovery period after COVID (whenever that might be), the effects could “catch up” to us, thus making investors more hesitant to back companies and spur on further economic growth.

Similarly, it follows that civilians might want to spend as little as possible, and also avoid investing opportunities and hold onto whatever money they have while markets recover.

How Stagnation Impacts Investors

A slowdown of economic activity lasting several months sounds like it can only be a bad thing. But a recession does not necessarily mean the death knell for finances—in our recession help center, there are tons of definitions and resources to help readers better understand deep-dive details on these market conditions, including what to know about stock market corrections and tips on managing money during volatile conditions.

For some investors there are, perhaps surprisingly, compelling strategies to consider when the market is down. Volatility may offer investors the opportunity to buy low and then make appreciable gains as the market corrects itself. More insights and information can be found in our guide to investing during a recession.

The Takeaway

At its core, stagflation is the confluence of the economy and price levels locking for an extended period of time into suboptimal levels. Stagflation has occurred before in the US—notably during the Nixon Shock of the early 1970s—and there is no reason to think it won’t happen again at some point.

While some investors will choose to sit tight during a stagflation, others might see an opportunity to buy low and then sell high once the market rights itself. As with any investment strategy, these decisions are deeply personal and the outcomes are never guaranteed.

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