What is Stagflation?

Stagflation is a period when high inflation, slow or shrinking economic output, and high unemployment all occur at the same time. The word blends stagnation and inflation, and it describes an economy where prices keep rising even though growth and hiring are weak.

British politician Iain Macleod coined the term in the House of Commons on 17 November 1965. Britain, he said, had “the worst of both worlds”: “not just inflation on the one side or stagnation on the other, but both of them together.” He called it “a sort of ‘stagflation’ situation.”

What Causes Stagflation?

A demand-driven boom pushes prices and employment up together, and a demand-driven slump pulls both down. Stagflation needs something that raises prices and lowers output at once.

A supply shock does that. When an essential input such as energy suddenly costs far more, businesses raise prices and cut production and jobs. This is cost-push inflation.

Expectations can then keep it going. Federal Reserve History’s account of the period describes households and businesses coming to anticipate rising prices and building that into wages and prices, so inflation persisted even as unemployment climbed. The same account puts the origin earlier, in monetary policy that let the money supply grow too fast from the mid-1960s, with the oil shocks adding to inflation that was already under way.

Why Stagflation Is Hard to Fix

Before the 1970s, policy leaned on the Phillips curve, the idea that inflation and unemployment move in opposite directions. In Federal Reserve History’s telling, policymakers believed permanently lower unemployment could be “bought” with modestly higher inflation. Economists Milton Friedman and Edmund Phelps argued the tradeoff would not hold once people expected the inflation, and the 1970s bore that out: both numbers rose together.

That leaves a central bank with one tool pointed in two directions. Raising interest rates cools inflation but slows borrowing, spending, and hiring in an economy that is already weak. Cutting rates supports jobs but adds to the price pressure.

Stagflation in the 1970s

The United States had two distinct episodes, each coinciding with an oil shock.

1973-1975: The First Oil Shock

Arab oil producers imposed an embargo in October 1973 that lasted until March 1974. According to Federal Reserve History, oil went from $2.90 a barrel before the embargo to $11.65 by January 1974. The National Bureau of Economic Research (NBER) dates a recession from November 1973 to March 1975, and prices kept climbing through it. Bureau of Labor Statistics (BLS) data show the Consumer Price Index (CPI) up 12.3% in the 12 months ending December 1974, while unemployment climbed from 4.6% in October 1973 to 9.0% in May 1975.

1979-1982: The Second Shock and the Volcker Fed

Oil prices more than doubled between April 1979 and April 1980 following the Iranian Revolution, per Federal Reserve History. The 12-month change in the CPI peaked at 14.8% in March 1980. Two recessions followed in quick succession, one from January to July 1980 and a longer one from July 1981 to November 1982.

Paul Volcker became Federal Reserve chairman in August 1979 and chose to fight inflation first. The federal funds rate peaked at a monthly average of about 19% in June 1981. BLS data show unemployment reaching 10.8% in November and December 1982, and by that December the 12-month CPI change was down to 3.8%.

Stagflation vs. Recession vs. Inflation

Stagflation pairs high inflation with a weak economy. A recession can be part of it, but growth only has to stall, not shrink.

Are We in Stagflation?

No agency declares stagflation, and no official threshold separates it from a rough patch, so any claim that an economy is or isn’t in it is a judgment call. You can check the three ingredients yourself. The BLS publishes the 12-month change in the CPI and the unemployment rate every month, and the Bureau of Economic Analysis publishes real Gross Domestic Product (GDP) every quarter.

One high reading doesn’t make it stagflation. The 1970s episodes combined double-digit inflation with recessions and sharply higher unemployment, and they played out over years.

How Stagflation Affects Your Money

For a household, stagflation means grocery and energy bills rise while raises get harder to win and layoffs become more likely. An emergency fund has to cover a bigger monthly bill, possibly through a longer job search.

A fixed-rate mortgage payment stays the same while prices rise, so it shrinks in inflation-adjusted terms, though that only helps if your income keeps pace. Variable-rate debt gets more expensive when a central bank raises rates to fight inflation.

Return data compiled by Aswath Damodaran at NYU Stern show the S&P 500 losing 14.3% in 1973 and 25.9% in 1974 including dividends, the two years of the first oil shock. Bonds didn’t cushion much: the 10-year Treasury yield rose from about 6.5% in January 1973 to a peak of 15.3% in September 1981, per Federal Reserve data, and bond prices fall as yields rise. What matters is the return after inflation. A portfolio that earns 2% while prices rise 8% has lost about 5.6% in inflation-adjusted terms.

If you’re near or in retirement, this is sequence of returns risk in its harshest form. Your withdrawals have to grow with prices just as the portfolio funding them is falling, so you sell more shares at lower values early on, and those shares aren’t there for a recovery. You can set a higher inflation rate at specific ages in ProjectionLab to see how your plan handles a spike in its early years.

How to Invest During Stagflation

No asset is a dependable winner in stagflation, and each candidate comes with a cost.

Treasury Inflation-Protected Securities (TIPS) adjust their principal with the CPI and pay at least the original principal at maturity, which makes them a direct inflation hedge. Their market prices still drop when real yields rise, so a TIPS fund can lose value in the short run. They also have no 1970s track record: the Treasury first auctioned them in January 1997.

Stocks are claims on businesses that can raise prices, but 1973-74 shows how far they can fall first. Selling after the drop locked in the loss: Damodaran’s data show the S&P 500 returning 37% in 1975. Cash and short-term bonds hold their nominal value and reprice quickly as rates rise, yet they lose purchasing power whenever inflation outruns the yield.

That leaves your asset allocation and your flexibility: enough in safer assets to avoid selling stocks after a fall, and spending you could trim for a few years. Running your plan through Chance of Success in ProjectionLab, where returns and inflation both vary from trial to trial, shows how much margin you have.

Frequently Asked Questions

What does stagflation mean in simple terms? Prices are going up fast while the economy is going nowhere. Your cost of living rises while jobs get scarcer, so you get the downside of inflation and the downside of a recession together.

What is the difference between stagnation and stagflation? Stagnation is weak or no economic growth, with nothing implied about prices. Stagflation is stagnation plus high inflation. An economy can stagnate with low or even falling prices, as Japan did after its asset bubble burst around 1990.

Is stagflation worse than a recession? For savers and investors it offers fewer offsets. When a recession brings inflation down, interest rates can fall and existing bonds gain value: in 1982 the 10-year Treasury bond returned 32.8%, according to Damodaran’s data. In stagflation, prices keep rising and rates may be going up, so bonds can lose value alongside stocks.

When did stagflation end in the United States? Federal Reserve History dates the Great Inflation from 1965 to 1982. The 1981-82 recession that brought inflation down ended in November 1982, by NBER’s dating, and Federal Reserve History reports inflation averaging 3.5% in the second half of the 1980s.