What Is Stagflation?

If you want to send shivers down an economist’s spine, all you have to do is say one strange-sounding word—stagflation.

We can hear the calculators dropping and balance sheets tearing right now.

Stagflation is an economic term that’s used to describe an unlikely combination of economic conditions: a stagnant (or struggling) economy and a rise in the prices of goods and services across the board (aka inflation). In other words, when economic stagnation meets high inflation, you get stagflation!

While we haven’t seen this depressing one-two punch since the 1970s, some economists are sounding the alarm that we might be heading toward another period of stagflation this year.

But we’re not there yet. So let’s break down what stagflation is, what causes it, and how it has played out in the past. Then, we’ll look at whether history will repeat itself—and what you can do to prepare.

What Is Stagflation?

Stagflation happens when slow economic growth, high inflation, and rising unemployment happen at the same time. (Just so you know, economic growth is measured by gross domestic product (GDP), which is the total value of all goods and services produced by the economy.)

Stagflation is pretty rare, though. Normally, when the economy is growing fast, inflation goes up. Makes sense, right? Businesses are humming along, profits are up, and people have more money to spend—so consumer demand causes prices to increase.

On the other hand, when the economy grows more slowly, inflation is usually lower because people have less money to spend.

Stagflation spits in the face of the normal rules of economics. And when a stagnant economy mixes with out-of-control inflation, it creates a nasty cocktail of economic conditions that leaves everyone feeling a bit woozy.

Usually, when the economy slows, it leads to fewer jobs and higher unemployment. That alone is tough—but stagflation makes it even worse because people have less money to spend while prices keep rising.

What Are the Causes of Stagflation?

There are lots of theories out there about what causes stagflation, but they mostly boil down to two factors: government policy and sudden changes in the supply of important goods.

Government Policy

Sometimes, when the government tries to fix something, it ends up making things worse. Shocker.

In an effort to get a slow economy moving, the government might increase the money supply by printing more money or making it easier to borrow money by lowering interest rates. The problem is, at some point, there might be too many dollars out there and not enough goods.

What happens when supply can’t meet demand? Stupid-high inflation. And if the government’s policies don’t get the economy going, you’re stuck with stagflation.

On the other hand, the government might try to fight inflation by raising interest rates and reducing the money supply. But higher interest rates can also slow down the economy—making it harder for businesses to grow and for people to borrow and spend. So if inflation doesn’t ease up, and the economy slows down at the same time, you could end up with stagflation.

Supply Shock

Another way stagflation might rear its ugly head is through an unexpected drop in the supply of an important product or commodity (like oil). This is also known as a supply shock, and it can trigger a domino effect that leads to a sudden rise in prices throughout the economy (especially for things like gas and food).

Start budgeting with EveryDollar today!

Supply shortages often make it more expensive to produce certain goods and  transport them from place to place. To make up for those rising costs, companies might increase prices, lay off some of their employees, or both. Yikes!

Examples of Stagflation

For the longest time, people thought stagflation wasn’t really possible. After all, how could prices go up if the economy was stalled or even shrinking? When people have less money to spend, consumer demand drops . . . and prices usually drop with that falling demand.

But then the 1970s happened. While disco and bell-bottom jeans were all the rage, a toxic combination of events and economic factors led to a period of stagflation (dun-dun-dun). 

Here’s what happened: In the early ’70s, oil prices skyrocketed because of an oil embargo, making it more expensive to produce and transport goods. This had a devastating ripple effect across the economy. Those rising oil prices, along with a bunch of other supply shortages, led to soaring inflation and a global recession—which meant that prices for everything from milk to gasoline were climbing while more and more Americans found themselves out of work.

The Federal Reserve tried to kick-start the economy by pumping more money into it and cutting interest rates. They thought these actions would make it easier for folks to borrow money and spend it, boosting economic growth in the process.

But there was a problem: Businesses weren’t able to produce enough goods and services to meet the rise in demand, so all that extra money just made things more expensive.

Expecting production costs to rise, businesses started laying off workers. As more and more workers made their way to the unemployment line, the United States went through a couple of nasty recessions and a period marked by what economists call malaise. This is just a way of saying that the economy was moving super slow—kind of like Monday morning after a weekend of fun.  

It wasn’t until the early 1980s that the Federal Reserve—under new chairman Paul Volcker—cut the money supply and hiked interest rates to try to make it more expensive for businesses and individuals to borrow money. They were hoping to stop inflation in its tracks.

At first, those actions caused some short-term pain—economic output dropped and unemployment hit 10%. But then something happened: Prices stopped rising, the economy gradually recovered, and supply and demand balanced out. Finally, people said goodbye to that era of stagflation. Good riddance—just like disco!

Are We Heading Toward Another Era of Stagflation?

A lot of economists are wondering out loud whether we’re heading toward a rerun of stagflation—something we haven’t seen in half a century.

Part of that concern comes from President Trump’s proposed economic policies, which include issuing large tariffs—taxes on goods coming in and (sometimes) going out of the U.S. These tariffs will make those imported goods more expensive, especially if countries like Mexico and Canada (some of our major trading partners) retaliate with their own high tariffs.

All this tariff talk has made some economic analysts pretty nervous—and the stock market has reacted accordingly, losing most of its gains since Trump took office.¹ The market hates uncertainty, and President Trump’s policy brings a lot of that with it (at least right now). To top it all off, inflation hasn’t come down as much as analysts would have hoped.

So, are we entering a period of stagflation? The answer is maybe, but it’s still way too early to know for sure.

How to Combat Stagflation

Here’s the thing: All this stagflation talk is speculation. Guesswork. President Trump just took office in January, and the results of his policies can’t really be measured yet. People are just getting nervous about what might happen (which is part their fault for overhyping and part Trump’s fault for the uncertainty).

You can’t change what market analysts and politicians do, so it’s best to focus on what you can personally control. Whether stagflation happens or not, there are things you can do right now to prepare for inflation and other economic challenges. They may not hit today, but they will eventually come as a natural part of the economic cycle.

1. Don’t panic.

Before you start stocking up on toilet paper (again) or buying every bag of flour you can get your hands on, take a deep breath and remember that the economy just struggles from time to time. And recessions are a normal part of the economic cycle.

When you start listening to all the Chicken Littles on the news and get swept up in fears of stagflation, inflation, deflation or any other scary economic term that ends in “flation,” you might start making financial decisions out of fear . . . and that never ends well.

2. Work the Baby Steps.

Use the possibility of economic hard times to motivate you to get gazelle intense about following the 7 Baby Steps. Whether you’re saving for an emergency fund or paying off debt, each step you take will give you more peace in the middle of a financial storm. And with interest rates on the rise, if you have debt with variable rates, paying it off will save you even more cash.

3. Adjust your budget.

You can’t control what it costs to fill up your car or buy a gallon of milk. All you can do is adapt to the reality of the situation you’re living in. When you sit down with your spouse to talk about your budget, it might mean having some tough conversations—like cutting back on nonessential things such as dining out or entertainment to make up for the rising costs of essential budget items.

4. Look for ways to save.

Do you have a coworker you can carpool to work with? Can you switch to generic brands on some grocery items? Are there any subscriptions or streaming services you barely use that you can cut? It might not seem like much, but all those small steps can add up to big savings over time.

5. Invest to stay ahead of inflation.

Inflation might hurt a little bit now, but it will really hurt you 20 or 30 years down the line if you don’t stay ahead of it.

But how do you stay ahead? By investing in mutual funds that will grow your money faster than the rate of inflation. Historically, inflation increases the price of goods and services on average around 3% each year. Meanwhile, the stock market has an average annual rate of return between 10–12%.²

So, if you’re out of debt with a fully funded emergency fund in place, then it’s time to start investing in good growth stock mutual funds that can help you save for retirement and keep you ahead of inflation!

The best way to start investing is to work with a SmartVestor Pro. They are committed to helping you set up a plan to invest for the future, and they’ll keep you on track—whether the economy is booming or in a slump.

Get Your Finances in Order

Look, there are lots of things that are beyond your control. You can’t control inflation. You can’t control gas prices. You can’t control what’s happening in Washington, D.C. And you can’t control whether stagflation is going to happen.

But in the middle of all these things you can’t control, you can find peace by taking control of your finances. Not sure where to begin? Check out our free budgeting app, EveryDollar.

This awesome app is the easiest way to stay on top of your money and make sure you know where it’s going instead of wondering where it went. When you’re in control of your money, you're less likely to feel the stagflation squeeze on your wallet!

Sign up today and start using EveryDollar.