Stagflation: Definition, History, Causes, and Warning Signs

Key takeaways
* Stagflation is the simultaneous occurrence of slow economic growth, high unemployment, and rising prices.
* It is hard to address because policies that combat inflation tend to slow growth, and policies that stimulate growth tend to raise inflation.
* Major supply shocks (like oil crises or abrupt tariffs) and de-anchored inflation expectations are common triggers.
* Watch for rising input costs, supply disruptions, and persistent inflation alongside slowing GDP as early warning signs.

What is stagflation?

Stagflation is an economic condition in which stagnant (or declining) economic output and high unemployment coincide with persistent inflation. Unlike typical cycles where inflation rises with strong growth and falls during recessions, stagflation combines the worst features of both high prices and weak labor markets, making it particularly painful for households and difficult for policymakers to resolve.

A practical measure of stagflation’s severity is the “misery index” — the sum of the unemployment rate and the inflation rate — which rises when jobs become scarcer and purchasing power erodes.

Brief history

The term emerged in the 1960s and became widely used during the 1970s, when oil embargoes sharply raised energy costs across advanced economies. That supply shock simultaneously pushed prices up and economic output down, producing prolonged high inflation alongside rising unemployment.

Policymakers eventually tamed that era’s inflation through very tight monetary policy, which brought inflation under control but also triggered deep recessions and high unemployment before recovery. The episode reshaped central-bank thinking, emphasizing the importance of anchoring inflation expectations and communicating policy clearly.

What causes stagflation?

Major causes include:

• Supply shocks
• Sudden reductions in productive capacity or sharp increases in input costs (for example, oil price spikes, widespread trade barriers, or major supply-chain disruptions) raise prices while lowering output and employment.
• Policy miscues
• Conflicting or poorly timed interactions between fiscal policy (spending and taxes) and monetary policy (interest rates) can worsen both inflation and growth. Keeping interest rates too low while inflation is rising, or pursuing stimulus when supply constraints persist, can entrench inflation without restoring output.
• De-anchored inflation expectations
• If businesses and consumers begin to expect consistently higher inflation, they act in ways (raising prices, demanding bigger wage increases) that make inflation self-perpetuating. Once expectations become unanchored, breaking the cycle becomes more costly.

Why stagflation is hard to fight

Standard tools are partly contradictory:
* To lower inflation, central banks raise interest rates — this can slow demand and increase unemployment.
* To boost growth and employment, governments and central banks stimulate the economy — this can add upward pressure on prices when supply is constrained.

When inflation is driven by supply-side problems rather than excess demand, standard demand-management tools are less effective and can even aggravate the other half of the problem.

Warning signs

Be alert to these indicators that can precede or signal stagflation:
* Major supply disruptions (geopolitical conflicts, trade barriers, natural disasters).
* Persistent increases in input costs (energy, raw materials, imported goods).
* Declining productivity or weak output per worker combined with rising wages.
* Policy uncertainty or conflicting fiscal/monetary moves.
* Rising long-term inflation expectations among consumers and businesses.
* Slowing GDP growth over several quarters while inflation remains elevated.

The Phillips curve and recent dynamics

The Phillips curve originally suggested a stable trade-off between inflation and unemployment. Recent evidence shows that relationship has flattened or become nonlinear: big drops in unemployment no longer produce the same inflation increases they once did, and vice versa. That makes policy choices trickier because the historical link between labor markets and inflation is less predictable.

How trade barriers (tariffs) can trigger stagflation

Tariffs act like a supply shock by raising the cost of imported goods and inputs. Higher import costs can push consumer prices up (inflation) while reducing business investment and household spending, thereby slowing growth and potentially triggering layoffs. Rapid, large-scale tariffs can therefore create classic stagflationary pressures.

What stagflation means for households and policy

For individuals, stagflation is especially harmful: wages and job opportunities weaken while the cost of living rises, eroding savings and complicating financial planning. For policymakers, the trade-offs are acute: aggressive anti-inflation moves can deepen unemployment and recession; aggressive stimulus can entrench inflation. The policy response must balance restoring price stability with supporting sustainable growth, often requiring tough choices and strong central-bank credibility.

Conclusion

Stagflation merges high inflation with weak growth and rising unemployment, and it resists simple policy fixes because measures to cure one problem frequently worsen the others. Preventing and resolving stagflation typically depends on limiting severe supply shocks, maintaining credible monetary policy to anchor expectations, and coordinating fiscal and monetary responses so that policy actions do not work at cross-purposes.