Stagflation is a period of slow economic growth, heightened unemployment and high inflation. It’s greatly feared because it combines three undesirable economic conditions.
It’s also counterintuitive, because this shouldn’t occur based on basic principles of economic theory – namely, prices shouldn’t rise when consumers have less money to spend.
The term stagflation was coined by a British politician who described the United Kingdom’s high inflation and unemployment as a “stagflation situation” in a 1965 speech to the House of Commons.
The preceding period entailed the first global wave of debt accumulation amid low real interest rates around the world. And the U.S. deficit ballooned on heavy military spending during the Vietnam War.
Another likely contributing factor was the collapse of the global system of managed currency exchange rates as the Bretton Woods Agreement fell apart between 1968 and 1973.
Add in a tripling in crude oil prices as a result of the 1973-74 Oil Embargo and for a far more energy-dependent economy than we have today. And then the 1978-79 Oil Shock saw oil prices nearly triple again to close out the decade.
There had been a few prior recessions that raised unemployment without doing much to curtail inflation.
Stagflation is an infrequent economic phenomenon, which means central banks and governments haven’t had much practice contending with it. It’s a challenge for economic policymakers, as they need to resolve multiple problems that should never happen simultaneously.
Numerous economies entered technical recession territory in 2022, as they faced two consecutive quarters of negative GDP growth. Even if a global recession is averted, stagflation is still viewed as a very real threat in 2023.