Stagflation: What it is and how to prepare
Stagflation: What it is and how to prepare
Stagflation: What it is and how to prepare
The U.S. has only experienced one sustained period of stagflation in recent history, in the 1970s.1
What is stagflation?
Stagflation happens when several factors combine to create an especially difficult economic environment. To get stagflation, three things must occur together:
- Slow economic growth
- High inflation
- A high unemployment rate
Because stagflation includes hits to the economy from various angles, it can be difficult to recover from and can lead to long-term recession. For example, if an economy is experiencing only inflation, deflation can address the issue and help the economy recover. But if stagflation is at play, deflation alone may not spur fast recovery because slow growth and unemployment issues must also be addressed.
The history of stagflation
Stagflation last occurred in the U.S. when 1970s inflation met other factors, including federal budget deficits related to social spending and the Vietnam War, skyrocketing crude oil prices, high unemployment, a wave of debt accumulation across the globe and rising prices.2
Stagflation was a relatively common occurrence in the late 1970s and 1980s as economies across the globe bounced back from these factors.
Potential causes of stagflation
The causes of stagflation are varied and don't always include the exact same factors. National and global economies are complex, and changes in one area can have ripple effects that impact other areas in seemingly surprising ways. However, historic stagflation lets economists study trends and come up with potential common causes that might indicate stagflation is coming.
The oil price shock theory of stagflation says that when oil prices suddenly skyrocket, economies aren't able to keep up. The rising prices have a knock-on effect, meaning the cost of other goods and services goes up while outputs may fall. Supply issues begin to occur, and the economy in general doesn't function or perform as well as it once did.
While this theory usually highlights the cost of oil, due in part to oil's direct impact on stagflation in the 1970s, any major cost shock can have the same impact. To potentially cause such an impact, prices must rise substantially and quickly. They must also be prices associated with consumer goods or services that are required for daily life and can't be easily substituted by other things.
Poorly made economic policies
Like a recession, stagflation is a convergence of economic events that leads to a poor outcome. One driver of stagflation is poor economic policies that allow these converging factors to meet or increase to a level that they can't be overcome. In fact, the theories that said stagflation was impossible prior to the 1970s contributed to this cause. Because economists didn't think increasing interest rates and unemployment could happen at the same time, there weren't policies to address such potential outcomes.
Stagflation, however, isn't always something that governments can find their way out of with policy. Because this economic event is so multifaceted, it's difficult for policymakers to address. Acting to address it may lead to policies that make it worse.
Prior to the 1970s, U.S. dollars could be converted to gold. However, at the time, foreign governments had more U.S. dollars than the United States had gold. The administration at the time felt that allowing dollars to be exchanged for gold put the United States at risk, so the president at the time closed that process. And in 1976, a policy was instituted that severed the connection between dollars and gold — the value of the dollar was no longer based on gold.
These policies served to diminish the value of the dollar. When the value of the dollar falls, it can help drive other forces that lead to stagflation.
Stagflation vs. inflation
While stagflation includes rising inflation, it's not the same thing as inflation. Other economic factors must be prevalent for stagflation to occur. Thus, preparing for stagflation looks a bit different from preparing for inflation.
How to prepare for stagflation
Because stagflation is so complex and impacts entire economies in big ways, you probably can't prepare so that you're entirely immune. As with a large recession, stagflation typically has impacts on your investments and wealth-building processes. However, there are some personal finance moves you can make to help weather the storm of such an economic crisis.
Pay off debt
When you're not obligated to paying debt monthly, you will have more freedom to manage your earned income. In a period of stagflation, when prices may be rising, you need more disposable income to cover rising prices. If you don’t have loans and credit card balances to pay monthly, then a 10% increase in food prices may be uncomfortable but still manageable. However, if you carry so much debt that your income is covering your month-to-month expenses and debt interest payments, , then a 10% increase in food prices could be really challenging.
Make plans to pay off your debts or pay them down as much as you can. When possible, pay more than the minimum on balances or consider consolidating high-interest debt (especially variable rate debt) into lower-interest loans while these are still available.
Read more: How to pay off debt
Save an emergency fund
Create a buffer for yourself with an emergency fund and hold the money in an FDIC insured bank account. Most financial professionals recommend saving between three to six months' worth of basic expenses — which should be enough to cover your bills and basic living expenses in times of crisis. This way, if you experience a drop in income, lose your job, or face another type of emergency, you will have a safety net.
If having three to six months' worth of expenses sounds like an overwhelming goal, start small. Set a short-term goal to save a $1,000 as a rainy-day fund. After reaching this amount, you can work on saving a month's worth of expenses. Keep adding to your savings account over time, and eventually, you’ll reach the recommended safety net.
Improve professional marketability
High unemployment rates is one factor in stagflation. There are steps that you can take to improve the probability of retaining a position during a period of increasing layoffs, as well as to improving your marketability if you find yourself needing to search for a new job.
Consider the following:
- Asking to cross-train at your job so you know how to do more than one position, which makes you valuable to your employer and others
- Getting certifications or degrees in your niche
- Reach out to your professional network even when you still have a job
The bottom line
No one is immune to major changes in economies. However, those who have done the work to save for the future and create value for themselves are most prepared to weather major economic events.
1 CNN, "It’s not the 1970s but stagflation is back in the picture," August 2023.
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