What Is Stagflation? Causes and Why It's Bad

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Stagflation is an economic condition in which three problems occur at the same time: economic growth slows or stalls, unemployment is high or rising, and prices keep climbing. The word joins “stagnation” and “inflation.” Ordinary economic thinking pairs rising prices with booming demand and falling prices with recessions. Stagflation produces the pain of both at once: fewer jobs and less income, while each dollar buys less.

What Is Stagflation?

Stagflation describes a state of the whole economy, not a single price or a single industry. Three conditions define it:

1. Stagnant growth. Real output, usually measured by gross domestic product (GDP) adjusted for inflation, grows slowly, stops growing or shrinks.
2. High unemployment. Businesses hire less or cut jobs because demand and profits weaken.
3. Persistent inflation. The general price level keeps rising, often tracked through measures such as the Consumer Price Index (CPI).

No universally agreed numerical threshold turns a weak economy with inflation into “stagflation.” The label is a judgment that all three conditions are present and lasting rather than a brief overlap. A single quarter of weak growth while inflation is still easing from a peak is not the same as years of stalled output combined with prices that refuse to settle.

Why Is It Called Stagflation?

British politician Iain Macleod is credited with first using the term in a 1965 speech to the House of Commons, where he described the U.K. economy as suffering from both stagnation and inflation. The word stayed fairly obscure until the 1970s, when much of the developed world experienced exactly the combination he had named. “Stagflationary” is the adjective: a stagflationary shock, for example, is an event that pushes prices up and output down at the same time.

How Stagflation Works

The clearest way to see stagflation is through costs. In a typical demand-driven boom, consumers and businesses spend more, firms expand production to meet that demand, hiring rises, and prices rise because demand runs ahead of supply. Growth and inflation move together.

Stagflation usually starts from the other side of the economy: supply. When an essential input becomes more expensive or scarce, the cost of producing almost everything goes up. Energy is the classic case because it feeds into manufacturing, transport, farming and heating. A business facing a sharp rise in costs has two basic responses:

• Raise prices to protect margins, which feeds inflation.
• Cut output and staff because each unit is now less profitable and customers buy less at higher prices, which raises unemployment and slows growth.

Many firms do both. When that happens across a large part of the economy, prices rise while production and employment fall.

A Hypothetical Example

Consider an illustrative economy (all figures are invented for teaching purposes):

• An energy supply disruption raises fuel and electricity costs sharply.
• A manufacturer’s cost per unit rises by 10%. It raises its selling price by 8% and reduces production by 5%, laying off some workers.
• Trucking companies pass higher fuel costs on to retailers, who raise shelf prices.
• Households facing higher prices for energy, food and goods cut back on other spending, so restaurants and retailers reduce hiring.

Suppose that over a year, the general price level rises 7%, real GDP grows only 0.5%, and unemployment climbs from 4% to 6%. Nominal spending may still appear to grow, but almost all of that growth is higher prices rather than more goods and services: the economy shows rising dollar totals while producing roughly the same or less.

Measuring Severity: The Misery Index

One simple gauge of stagflation’s severity is the misery index, associated with economist Arthur Okun. It adds two rates together:

Misery index = inflation rate + unemployment rate

Using the hypothetical economy above, at the end of the year:

• Inflation rate: 7%
• Unemployment rate: 6%
• Misery index: 7 + 6 = 13

If the economy had started with 2% inflation and 4% unemployment, the index would have risen from 6 to 13, capturing the two problems households feel most directly. Its weakness is that it treats one point of inflation and one point of unemployment as equally painful and says nothing about growth itself, so it is a rough indicator rather than a definition.

Interpreting Stagflation

When economists ask whether an economy is in or near stagflation, they look at the direction and persistence of several indicators together: real GDP growth that is weak or negative over several quarters, unemployment that is rising or stuck at a high level, and inflation. The key test is inflation that stays above the central bank’s target (about 2% for the U.S. Federal Reserve) instead of falling as the economy weakens. In an ordinary recession, slack demand tends to pull inflation down. In stagflation, inflation stays high, which signals that cost pressures or expectations, not excess demand, are driving prices.

The Phillips Curve and Why Stagflation Surprised Economists

Before the 1970s, mainstream policy thinking relied heavily on the Phillips curve, which described an inverse link between unemployment and inflation: low unemployment came with higher inflation, high unemployment with lower inflation. Policymakers saw their job as choosing a point on that tradeoff.

Stagflation broke that picture. In the 1970s, both inflation and unemployment rose together, which the simple Phillips curve said should not happen. The modern version builds in inflation expectations: what people believe inflation will be shapes how they set prices and wages, so the tradeoff can shift. If everyone comes to expect high inflation, the economy can end up with high inflation and high unemployment at once.

What a “Flattened” Phillips Curve Means

In recent years, economists have described the Phillips curve as “flattened,” or possibly nonlinear: large moves in unemployment shift inflation less than the old relationship predicted. For stagflation, this means fighting inflation by slowing the economy costs more jobs per point of inflation removed.

What Causes Stagflation?

Economists still debate the causes of the 1970s episode. Three main explanations stand out, and they are not mutually exclusive.

Supply Shocks

The most widely accepted explanation centers on supply shocks: sudden events that reduce an economy’s productive capacity while raising costs. Supply depends on the factors of production, such as energy, raw materials, labor and capital, and a shock to any essential input ripples outward.

Examples of potential supply shocks include:

• Energy embargoes or production cuts.
• Wars or geopolitical conflict that disrupt trade routes or commodity supplies.
• Natural disasters or pandemics that close factories and ports.
• Large, rapid trade restrictions.

How Tariffs Can Act as a Stagflationary Shock

Tariffs are taxes on imports, and economists treat a large, fast increase in tariffs as a possible supply shock. The mechanism works in two directions at once:

• Prices rise. Importers pay the tariff and tend to pass much of that cost along. Domestic producers that use imported parts face higher input costs, and domestic competitors may raise prices because foreign rivals became more expensive.
• Growth weakens. Higher costs squeeze business margins and household budgets. Companies may delay investment and hiring, especially when trade policy is uncertain, and retaliatory tariffs from trading partners can hurt exporters.

When significant new U.S. tariffs were adopted in 2025, Federal Reserve Chair Jerome Powell said they were likely to raise inflation in the coming quarters, reviving comparisons with the 1970s. The size of the effect depends on how broad the tariffs are, how long they last, how much firms absorb versus pass on, and how trading partners respond, so the impact varies by industry.

Policy Errors

Bad policy can create or prolong stagflation. One risk is a clash between fiscal policy (government spending and taxation) and monetary policy (the central bank’s management of interest rates and money): if the government pushes prices up while the central bank tries to bring inflation down, the two work against each other.

Monetarist economists argued that the 1970s stagflation owed a great deal to policy mistakes. In their view, central banks kept interest rates too low for too long while inflation was rising, which fed an inflationary spiral. The public came to expect continued inflation, businesses raised prices preemptively, and long-term investment suffered.

Supply shocks make such mistakes more likely. No government or central bank can reopen a blocked shipping lane or produce more oil, and because interest rates work mainly on demand, raising them against supply-driven inflation can slow the economy further without fixing the shortage.

De-Anchored Inflation Expectations

Inflation expectations are the rate at which consumers, businesses and investors expect prices to rise. Central bankers call expectations anchored when they stay close to the target and react little to temporary price swings, a usage that spread after a 2007 speech by then Fed Chair Ben Bernanke.

Anchoring matters because expectations feed into actual inflation. As a hypothetical example, if businesses and workers expect prices to rise 3% over the next year, firms will want to raise prices by at least 3% and employees will push for raises that keep up. If expectations rise to 4%, price and wage decisions tend to move up with them.

When expectations become de-anchored, this can turn into a wage-price spiral: rising prices lead workers to demand higher wages, higher wages raise business costs, and businesses raise prices again. Bernanke and other Fed officials have argued that unstable expectations helped drive the high inflation of the 1970s and early 1980s, and that the spiral was hard to stop even when unemployment was high. This is how a one-time price jump can become lasting stagflation.

Example of Stagflation: The 1970s

The 1970s became the textbook case. In 1973, OPEC imposed an oil embargo, and energy prices surged in the United States and Europe, raising production and transportation costs throughout the economy. Rising unemployment and accelerating inflation persisted through the decade.

The end of the episode shows how costly the cure can be. In the late 1970s, Fed Chair Paul Volcker led a sharp monetary tightening to break the inflationary spiral, and the federal funds rate peaked at roughly 19% to 20% in 1981, depending on the measure. Two recessions followed in the early 1980s, and the U.S. unemployment rate reached 10.8% in 1982. Inflation came down, but only after severe economic pain.

Policymakers drew several lasting lessons from the period, though not every economist agrees on all of them:

1. Central bank credibility keeps expectations in check. When people trust the central bank to keep prices stable, they are less likely to raise prices or demand wages in anticipation of inflation.
2. Supply shocks need different responses than demand swings. Higher rates can cool excess spending but are less effective against inflation caused by lost production capacity or higher input costs.
3. Timing and communication shape results. Clear guidance about policy intentions helps steer expectations, and the Fed has since moved from relative secrecy toward much more public communication.

Since the early 1980s, central banks have placed greater weight on keeping inflation low and stable, although the Fed still operates under a dual mandate of maximum employment and stable prices.

Why Stagflation Is So Hard to Fight

Stagflation is generally considered harder to resolve than either a standard bout of inflation or a recession, because the tools aimed at one problem worsen the other:

In stagflation, unlike a normal recession or a normal bout of inflation, every choice has a serious downside, which helps explain why stagflationary periods tend to be prolonged.

How an Economy Gets Out of Stagflation

There is no painless exit, but the main routes are:

• Monetary tightening to restore credibility, as in the Volcker era: accepting a recession to bring inflation and expectations back down.
• Resolution of the supply shock, such as energy supplies returning to normal or trade restrictions being lifted, which removes the source of rising costs.
• Supply-side improvements, such as policies that raise productivity or expand capacity, so the economy can produce more at lower cost. These tend to work slowly.

In practice, recoveries often combine these, and the order matters. Easing policy before expectations are re-anchored risks reigniting inflation.

The Harms of Stagflation

For individuals, stagflation creates a double burden:

• Lower real income. Wages often fail to keep pace with prices, so purchasing power falls even when paychecks rise in dollar terms.
• Job insecurity. Layoffs and hiring freezes make it harder to switch jobs for a raise or to find work after losing a job.
• Eroding savings. Cash and fixed-rate savings lose value in real terms when inflation exceeds the interest they earn.
• Higher borrowing costs if the central bank raises rates to fight inflation, affecting mortgages, credit cards and business loans.

For investors, the mechanisms point in uncomfortable directions. Higher interest rates and slower earnings growth can both weigh on stock valuations, such as those in the S&P 500, while inflation reduces the real value of fixed bond payments. Businesses face rising costs and weaker demand at the same time, which squeezes profit margins.

Stagflation Warning Signs

Economists watch for conditions that raise the risk of stagflation:

1. Supply disruptions from geopolitical conflict, trade restrictions or disasters.
2. Rising input costs for energy, materials or labor that outpace productivity growth.
3. Declining productivity, especially when output per worker falls while wages rise.
4. Policy uncertainty that makes it hard for businesses to plan hiring and investment.
5. Rising long-term inflation expectations, a sign that expectations may be de-anchoring and that higher inflation could become self-fulfilling.

None of these alone means stagflation is coming. The risk rises when several appear together and inflation fails to ease as growth slows.

Stagflation vs. Related Terms

• Inflation is a rise in the general price level. It can occur in a strong, growing economy with low unemployment. Stagflation is inflation combined with stagnation.
• Recession is a significant, broad decline in economic activity. Recessions usually bring falling or slowing inflation. Stagflation is a recession or near-recession in which inflation stays high.
• Deflation is a falling general price level, often linked to weak demand. It is roughly the opposite price problem: stagnation with falling rather than rising prices.
• Hyperinflation is extremely rapid, accelerating inflation. It can coincide with economic collapse, but the term describes the price explosion, not the growth and jobs picture.
• Disinflation is a slowing rate of inflation, with prices still rising but more slowly. An economy leaving stagflation usually passes through disinflation.

Limitations of the Concept

Stagflation is a useful but imprecise label. Without an official threshold, analysts can disagree about whether a period qualifies, and commentators sometimes use the term loosely for any mix of weak data and above-target inflation. The causes are also contested: the supply-shock, policy-error and expectations explanations each capture part of the 1970s experience, and their relative weight still divides economists. Today’s economies also differ from those of the 1970s in energy intensity, labor markets and central bank independence, and the mid-2020s U.S. economy carries much higher debt, which could narrow the room governments and central banks have to respond. Historical comparisons help explain the mechanism, but they do not predict how a future episode would unfold.

The Bottom Line

Stagflation matters to workers, savers and investors because it combines weaker job prospects with a rising cost of living, while cash and fixed bond payments lose real value. Policymakers face a hard tradeoff, since raising rates deepens the slowdown and stimulus adds to inflation. The 1970s show that recovery usually takes resolving the supply shock, restoring central bank credibility, or accepting a painful recession.