What is Stagflation? A Simple Guide

Stagflation is the difficult combination of stagnant growth, high unemployment and high inflation at the same time. It is troubling because the usual cures for one problem worsen the other: fighting inflation can deepen the slowdown, while boosting growth can fuel inflation. It leaves policymakers few good options.

Normally, weak growth comes with low inflation, and strong growth with higher inflation. Stagflation breaks that rule, pairing a stagnant economy with rising prices.

This guide explains what stagflation is and why it is so hard to fix.

Key Takeaways

• Stagflation combines stagnant growth with high inflation.
• It usually comes with high unemployment.
• It breaks the normal growth-inflation link.
• The usual cures for one problem worsen the other.
• It leaves policymakers with hard choices.

What is stagflation?

Stagflation is a rare and painful mix of three things at once: a stagnant or shrinking economy, high unemployment, and high inflation. Normally, a weak economy cools inflation, so having stagnation and high inflation together is unusual and especially difficult for policymakers to handle.

Why is stagflation so hard to fix?

The standard tools work against each other. To fight inflation, a central bank raises interest rates, but that slows the economy further and can raise unemployment. To boost growth, it cuts rates, but that can push inflation even higher. Every remedy for one part of the problem tends to worsen another.

What causes stagflation?

A common trigger is a supply shock, such as a sharp rise in oil prices, which raises costs and prices while also choking growth. Prices go up even as the economy slows, producing the toxic mix. Poor policy can also contribute. Whatever the cause, the combination is what makes it dangerous.

Why do investors fear stagflation?

Stagflation is hard for most assets. High inflation erodes bonds and cash, while weak growth hurts company earnings and shares. Few investments do well when the economy stalls and prices rise together. This is why the mere prospect of stagflation can unsettle markets broadly.

How is stagflation different from a normal recession?

In a normal recession, weak demand usually brings inflation down, so policymakers can cut interest rates freely to support the economy without much worry about prices. In stagflation, inflation stays high even as growth weakens, which limits how much policymakers can stimulate without making inflation worse. This combination makes stagflation harder to treat than an ordinary downturn, because the usual remedy of cutting rates risks fuelling the inflation that is already a problem.

What is the wage-price spiral?

A wage-price spiral can make stagflation worse and more persistent. When prices rise, workers demand higher wages to keep up; when wages rise, businesses raise prices to cover the higher costs; and the cycle repeats. In stagflation this spiral can continue even as growth stalls, because the initial inflation came from a cost shock rather than strong demand. Breaking the spiral often requires firm action to convince everyone that inflation will come down, which can involve a painful period of slower growth.

Economic data, policy and rates change over time and affect markets in complex ways. This article is educational, uses figures for illustration only, and does not constitute investment advice.

Frequently Asked Questions