Stagflation is a mash-up term combining the words stagnation and inflation . It describes an economy that is malfunctioning, in which prices keep soaring while economic growth — the rate of increase in the output of goods and services — slumps. The lack of economic growth over time can lead to higher unemployment. Under stagflation, households and businesses begin to worry that inflation will continue to soar over the long haul, which becomes a self-fulfilling prophecy, causing them to adjust their economic behavior in a way that ensures inflation will continue. The term came into use in the 1970s, when economists and central bankers were flummoxed by an unusual period of high inflation and weak economic growth sparked by twin oil shocks. Overall, stagflation defines “a macro economy that’s not working very well,” says David Wilcox, a senior economist at the Peterson Institute for International Economics and Bloomberg Economics.

Why is stagflation bad?

People are generally happier when the economy is booming and prices are low. “If you’re getting the opposite of those two things — if things are getting more expensive all the time but you’re not able to consume more and you may lose your job as well, that is bad,” said Brian Coulton, an economist in London with the ratings agency Fitch Group. Stagflation is also hard to fix. The job largely falls to central bankers such as the Federal Reserve, which exists to ensure a stable economy. Generally, the Fed aims to keep inflation around 2 percent. Usually, when inflation exceeds that level, the Fed and other central banks will raise interest rates, making it more expensive for households and businesses to borrow money, which discourages spending and tamps down price increases. That all becomes harder when the population is convinced that inflation is here to stay, Wilcox said. That then forces central bankers to raise interest rates more aggressively to try to bring inflation under control, which can slow growth even more dramatically.

Why is stagflation a risk now?

The United States and the global economy are experiencing inflation rates not seen in decades . Those rising prices have largely been caused by disruptions in the supply of goods and shifting consumer demands. The pandemic forced factories to shut down for weeks or months at a time, a problem still plaguing the world’s biggest manufacturer, China, where draconian lockdowns to prevent infection spread have kept ports and manufacturing facilities from operating as normal. Russia’s invasion of Ukraine has worsened the problem, disrupting Russia’s oil and gas exports and leading to global energy-price inflation. Russia’s blockade of grain exports from Ukraine , one of the world’s biggest wheat producers, is also driving up food prices globally and sparking worries about hunger in the developing world. Some of those same factors have weakened global economic growth. The World Bank on Tuesday slashed its annual growth forecast to 2.9 percent from January’s 4.1 percent and forecast the sharpest slump after an initial post-recession rebound that the global economy has suffered in more than 80 years.

Is it possible to avoid stagflation?

Avoiding stagflation is difficult, because financial regulators have to balance two competing interests: inflation and unemployment. Dealing with inflation usually involves hiking interest rates, making it more expensive to borrow money. That depresses consumer demand and makes running a business more expensive. Employers often respond by trimming their workforces, sending unemployment up. Conversely, central bankers could try to lower unemployment by cutting interest rates, creating incentive for employers to make large investments, hire and take market risks. But when employers hire, wages rise. And when wages rise, consumer prices go up (i.e.: inflation). So regulators are mostly stuck when it comes to stagflation. The conventional wisdom on solving stagflation is to deal with inflation by raising rates and sacrificing economic growth and higher unemployment. The rationale is that the market recovers faster from unemployment than it does from persistently high consumer prices. “The only known remedy for stagflation is a recession,” Wilcox said. “The Fed would have to cause unemployment to go up; it would have to cause a recession to convince the public it is serious about the 2 percent objective, and that they need to reset their expectations, their wage demands, their pricing behavior so it is consistent with that 2 percent.” All that said, a major driver of stagflation is high commodity prices — things like oil, wheat, steel and other foundational market items. As commodity prices rise, everything else in the economy becomes more expensive, too. One way to tame those prices is deregulating those industries, more conservative economists say, but it can take months or years for those effects to reach a producer’s bottom line. Policymakers generally want to address stagflation on a more accelerated timeline.

Has stagflation happened before?

Yes. The most recent stagflationary period was from 1973 to the early 1980s. Commodity prices were already high when OPEC, a consortium of oil-producing countries, cut off exports to the United States, the United Kingdom, Canada and other nations because of their support of Israel in the Yom Kippur War. That created a dangerous combination of economic factors. Oil prices skyrocketed 300 percent within a year. Prices on other commodities jumped, too. Employers, responding to the price shocks, cut their workforces, leading to high unemployment. The phenomenon baffled policymakers, who had assumed inflation and unemployment had an inverse relationship. They were wrong, and the U.S. regulatory framework lacked a playbook to address stagflation. The crisis dragged on until Western economies were able to build out their own commodity production capacity to compete with sometimes-adversarial exporting nations.

Is stagflation different from a recession?

Yes, for a few reasons. One aspect of stagflation is low or stagnant growth in economic output, whereas in a recession, economic output declines. During stagflation in the 1970s, “the economy was neither booming nor busting — it was trundling along, not in recession,” Wilcox said. Another difference: Normally a recession leads to low inflation or even a cut in prices for goods and services, whereas stagflation comes with high inflation. But ridding an economy of stagflation may require central bankers to push the economy into recession to finally curb spending and bring inflation under control, Wilcox said.

What happens if stagflation is here for years?

If stagflation is here for years in developed economies, something has gone horribly wrong. The main method of dealing with stagflation is eliminating inflation and allowing the market to naturally repel unemployment. In other words, the goal is to turn a stagflationary market into a recessionary market, and recessions typically resolve in a little less than a year. In developed markets like the United States, the euro zone and Japan, that will mean some hard times for consumers and periods where hundreds of thousands of people probably will lose their jobs. But on the other side of the recession, wages will be higher — wage growth that tracks with inflation generally persists after inflation cools — and investment markets will stabilize and employers will staff up again. The real long-term risk is in emerging and developing economies, such as Brazil, Russia, India, China and South Africa. They are all major exporters whose markets rely on importing countries to sustain growth. If the economy contracts — especially the Western consumer economy — developing countries will have fewer places to send their stuff. Those economies are also heavily dependent upon foreign investment, but if international markets are turbulent, businesses are likely to pull back from developing countries whose economies are more risk-prone. That could lead to credit crises in developing market nations that could hamper the global financial recovery.

Economy

What is stagflation? Here’s why it matters and what you should know.

Inflation and weakening growth could trap the global economy in a years-long slump, economists warn

By Jacob Bogage

and

Jeanne Whalen

June 8, 2022 at 6:00 a.m. EDT

Cars line up in two directions at a gas station in New York City in 1973. (Marty Lederhandler/AP)

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The global economy could be heading for slow growth, rising prices and high unemployment, economists are warning, a toxic brew that could hamper countries’ recovery from the coronavirus pandemic.

The World Bank on Tuesday warned that those forces, called “stagflation,” could induce years’ worth of struggles. And persistent challenges — such as supply chain snags, Russia’s attack on Ukraine and continuing waves of covid-19 cases — could harm consumers and employers alike, settling world markets into a downturn that they largely avoided when the pandemic first struck.

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Here’s what you need to know about stagflation and the risk it presents to the global economy: