Stagflation is a word coined from "stagnation" and "inflation" to describe an economy suffering both at once: growth is weak or negative and unemployment is high, yet prices are rising quickly. Ordinarily those two conditions do not travel together. A weak economy usually drags prices down, and a hot economy usually pulls them up, so policymakers can lean against whichever problem dominates. Stagflation removes that convenience, because leaning against either problem makes the other worse.
Stagflation
Stagflation is the uncomfortable combination of a stagnant economy, high unemployment and weak growth, occurring at the same time as high inflation. It is difficult because the usual cures for one problem worsen the other.
Last reviewed by Steven Fox, CFP®, EA
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Quick Summary
- Stagflation means stagnation and inflation together, high unemployment and slow growth alongside rising prices.
- It is a problem because the standard policy response to weak growth tends to add to inflation, and the response to inflation tends to deepen the slump.
- The classic example is the United States in the 1970s, when oil shocks pushed up prices while output and employment fell.
- It is usually blamed on a supply shock, an event that makes production more expensive across the economy at once.
Definition
Advanced Explanation
For much of the mid-twentieth century, economists worked with a rule of thumb that unemployment and inflation moved in opposite directions: a booming economy with low unemployment ran hot and inflationary, while a slack economy with high unemployment ran cool and disinflationary. That inverse relationship is the Phillips curve, and it implied a menu of choices, more inflation for less unemployment or the reverse.
The 1970s broke the menu. The United States experienced high unemployment, sluggish growth and double-digit inflation simultaneously, a combination the simple trade-off said should not happen. The trigger was a series of supply shocks, most famously the 1973 oil embargo, which sharply raised the price of energy and therefore the cost of producing almost everything. A supply shock is what makes stagflation possible: it pushes prices up and output down at the same time, hitting both halves of the economy from one direction.
The reason stagflation is so hard to treat is that the two problems call for opposite medicine. To fight high inflation, a central bank raises interest rates and tightens monetary policy, which slows the economy and tends to raise unemployment. To fight high unemployment, it cuts rates and government may increase spending through fiscal policy, which supports demand but tends to add to inflation. Faced with both at once, a policymaker cannot ease one without aggravating the other, and has to choose which to attack first. The historical resolution of the 1970s episode came from prolonged high interest rates that eventually brought inflation down at the cost of a sharp recession.
Used in a Sentence
“Economists debated whether the surge in energy and food prices during a period of weak growth amounted to genuine stagflation or merely a temporary supply shock that would fade once production caught up.”
How It Works
There is no single official measure of stagflation; it is a description of two indicators pointing the wrong way together. An observer looks at the inflation rate and at measures of economic slack, chiefly the unemployment rate and the change in gross domestic product, and calls it stagflation when inflation is high while growth is weak and unemployment elevated.
A hypothetical shows the policy bind. Imagine an economy where inflation is running near 8% while unemployment sits at 8% and output is flat. A central bank that raises interest rates hard enough to break the 8% inflation will slow borrowing and hiring further, pushing unemployment toward, say, 10% before prices cool. A government that instead spends to pull unemployment down toward 5% adds demand to an economy whose prices are already climbing, and inflation may reach double digits. Neither lever fixes both numbers, which is why stagflation forces a genuinely painful choice rather than a straightforward correction.
Pros and Cons
Why stagflation is considered especially difficult
- The standard response to weak growth (looser policy) tends to worsen inflation.
- The standard response to high inflation (tighter policy) tends to worsen unemployment and growth.
- It is usually driven by a supply shock, which policy aimed at demand cannot directly undo.
- Households feel it acutely: prices rise while jobs and income are scarce, squeezing budgets from both sides.
What can bring it to an end
- Sustained tight monetary policy can eventually break inflation, though often at the cost of a recession.
- Once the supply shock that caused it fades (for example, energy prices stabilizing), both problems can ease.
People Also Asked
Answers to the most frequently asked questions.
What causes stagflation?
The usual cause is a supply shock, an event that raises the cost of production across the economy at once, such as a sharp jump in energy prices. That pushes prices up while also reducing output and employment, so inflation and stagnation appear together. Poorly designed policy can contribute, but the defining ingredient is a shock that hits both prices and production from the same direction.
When did the United States experience stagflation?
The classic episode was the 1970s, when the economy suffered high unemployment and weak growth alongside double-digit inflation, driven largely by oil-price shocks including the 1973 embargo. It was this period that broke economists' confidence in a simple, stable trade-off between inflation and unemployment.
Why is stagflation harder to fix than a normal recession?
In an ordinary recession, prices are soft, so a central bank can cut interest rates and government can spend to revive the economy without worrying much about inflation. In stagflation, inflation is already high, so those same stimulus tools risk making prices worse. The policymaker cannot address unemployment and inflation with the same move, and must accept pain on one front to make progress on the other.
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