Understanding Stagflation: What It Is and How It Affects You

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As the U.S. Federal Reserve seeks to fight inflation through a series of interest rate hikes, some experts are predicting stagflation, rather than a recession. Late last year, The Conference Board called the economic climate “stagflationary.” But, by strict definitions, the U.S. has not yet reached a period of stagflation.

What Is Stagflation?

Stagflation, formed from stagnation and inflation, is when a country’s economy exhibits high inflation and slow or negative growth, but high unemployment rates. Right now, the unemployment rate is at just 3.6%, with growth in government, health care, social assistance and construction.

However, the inflation rate continues to rise as of June 2023, increasing 0.2% since May. Over the last 12 months, the U.S. has experienced 3% inflation before seasonal adjustment, according to the latest Consumer Price Index.

Additionally, the GDP continues to rise in 2023, with a 2% increase in the first quarter. This growth was slightly lower than the prior quarter, which showed a 2.6% increase. Therefore, the U.S. is only exhibiting high inflation right now, in the absence of negative growth or high unemployment.

What Happens During Stagflation?

During stagflation, prices will continue rising but jobs will be harder to find. Wages may not keep pace with inflation, which will, in turn, lead to halted economic growth. People and businesses, alike, may feel insecure about spending money.

Typically, due to supply and demand, reduced sales lead to lower prices or at least less inflation. But, during stagflation, other factors will keep prices rising in spite of a lack of spending.

What Does Stagflation Mean for the U.S.?

If the U.S. enters a period of stagflation, prices will continue rising even as companies attempt to cut costs through layoffs or pay cuts. With interest rates still high, it may be harder to borrow the money you might need to make ends meet if you lose your job. And any emergency savings you’ve tucked away won’t have as much buying power in the face of inflation.  

Factors apart from consumer and business spending can impact inflation. Some include:

• High oil prices
• Low-interest rates
• Trade sanctions and tariffs

The U.S. today is experiencing high transportation costs and elevated oil prices because of the Ukraine War. Additionally, tariffs on Chinese imports have increased the prices of electronics that U.S. businesses and consumers rely on.

The Fed’s interest rate hikes have, so far, failed to have the desired effect on the housing market to reduce home prices. Typically, when interest rates are higher, it becomes a buyers’ market and home prices drop to encourage faster sales.

But in spite of mortgages costing more today than during the pandemic when interest rates sat near zero, housing prices continue to rise.

Is Stagflation Worse Than Recession?

During a recession, a country’s economy has slow growth, coupled with high unemployment. But these factors tend to reduce inflation since spending also slows as a reaction to consumer fear. When prices remain elevated due to other factors, stagflation occurs.

Stagflation may be worse than a recession for many people. At a time when people are losing jobs, prices remain elevated. This can lead to food insecurity, foreclosures or homelessness. Financial struggles will impact almost everyone except for the wealthiest people in a society.

Stagflation is also harder to fight since it’s so unpredictable. Increasing interest rates to slow inflation can compound job loss and slow economic growth to undesirable levels. Experts agree it’s generally easier to avoid stagflation than to stop it once it starts.

Stagflation History

Stagflation first reared its head in the U.S. in the 1970s when gas shortages drove oil prices by more than 35% between 1973 and 1974. For the first time ever, a gallon of gas in the U.S. cost more than 50 cents.

The Federal Reserve chairman at the time, Paul Volcker, raised the interest rate higher than 21% to try to stem inflation. Instead, the higher interest rates lowered economic output and increased unemployment, leading to stagflation.

In recent years, the Fed has also raised interest rates to try to stem inflation. But, under the leadership of Jerome Powell, the Fed is aiming for a “soft landing.” It has slowed rate hikes in recent months in the hopes of preventing both stagflation or a recession.

Will Your Portfolio Survive Stagflation?

In addition to looking at your budget to see where you can cut costs, you should continue investing during stagflation if you can. Investments like 401(k)s, IRAs and stocks are likely to fall, so it’s best not to cash them out — or even look at them if it causes emotional stress.

Here are some investments to consider:

• Value stocks: These can grow once stagflation ends.
• Precious metals: Tend to hold their value.
• Commodities: Rise as the price of consumer goods go up.
• Commodity ETFs: These investments track the prices of similar commodities in one fund.

Keep in mind that stocks, ETFs, commodities and even precious metals can be volatile. Any investment carries risk, so you will want to invest in line with your risk tolerance.

Final Note

The U.S. has not yet entered a period of stagflation since unemployment remains low. But if the Fed can’t curb inflation before a recession begins, the nation could experience stagflation similar to the 1970s.

A recent U.S. inflation report suggests that the pandemic-era stimulus funds and subsequent interest rate hikes could have been the right decision, according to experts. Ideally, the U.S. will avoid stagflation, as inflation appears to be cooling.  

Information is accurate as of July 21, 2023. 

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