What’s stagflation and why does the rising risk of it matter?
When economic growth is stagnant and inflation is persistent, a rare economic phenomenon can occur
High inflation is bad enough on its own — but what about when it comes with high unemployment and stagnant economic growth? This pairing is what is known as stagflation, a rare economic phenomenon. And lately, concerns are cropping up that the U.S. economy could be showing signs of it.
“Persistent inflation above the Federal Reserve’s target and the job market slowdown had already prompted worries,” said CNBC. Then “surging oil prices due to the Iran war” entered the equation, bringing to mind the “oil supply shocks that led to shortages and long gas lines Americans saw during stagflation in the 1970s.” Still, many experts, including Federal Reserve Chairman Jerome Powell, maintain that the risks of stagflation reoccurring remain low.
What is stagflation, and why does it happen?
Stagflation — a blend of the words inflation and stagnation — refers to the combination of “stagnant economic growth, high unemployment and persistent inflation,” said Investopedia. This is a pattern that “defies traditional economic models, which typically show inflation rising during strong economic growth and falling during recessions.”
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Often, stagnation is attributed to supply-chain disruptions, such as to the oil supply. This can result in “a shortage of crucial goods or commodities,” which in turn “can lead to higher prices for consumers and a slowdown in economic growth,” said Yahoo Finance.
Another driver can be monetary policy decisions made by the Federal Reserve. For example, an “easy monetary policy where interest rates are being lowered combined with a tight fiscal policy can lead to wage retaliation if taxes remain too high,” said Kiplinger. “As workers demand higher wages, businesses may reduce employment and pass the higher costs onto consumers by raising prices.”
What are the risks of stagflation?
One of the “most noticeable effects of stagflation is higher prices for goods and services,” which can lead consumers “to spend more for everyday expenses and even take on debt to keep up with higher costs,” said Yahoo Finance. Additionally, people may experience “fewer job opportunities, lower wages or layoffs” as businesses instate cost-cutting measures to deal with the effects.
Together, this can make it more challenging to save and invest, which can have ripple effects down the road for people financially.
How can you protect yourself from stagflation?
To be clear, it is still up for debate whether or not the U.S. is nearing, or actually even showing real signs of, stagflation. Still, many of the steps you can take to prepare happen to be generally good financial practices anyway, including:
- Set aside money in savings, ideally a high-yield account, and make sure your emergency fund is well-stocked.
- Pay down debt — particularly high-interest debt like credit card debt.
- When it comes to investing, “stay the course and diversify,” said Kiplinger.
- Pay some attention to your career, whether that is by learning new skills to increase employability or exploring ways to boost income.
