Stagflation may be set for its first real return to the U.S. in about 50 years, as recent economic numbers point to a slowing labor market and continued stickiness in inflation. President Donald Trump’s new tariffs won’t help.
This risks creating a very difficult environment for consumers. Unemployment may increase and wage gains may slow, even as the cost of living goes up. Getting a new mortgage or car loan would also get more expensive.
Here’s what to know about stagflation.
Stagflation is when the economy slows or contracts, joblessness rises but prices go right on rising. It’s a problem that first came to prominence in the 1970s, and it remains a challenge for government officials — and especially central banks — because the usual policy toolkit doesn’t work well.
Usually, inflation is caused when demand for goods and services grows more quickly than supply. The policy response is normally to slow the economy, which since the 1980s has meant hiking interest rates. Under stagflation, higher interests costs may cool price gains, but can also trigger or worsen a recession.
The causes of stagflation aren’t entirely clear. In the 1970s, OPEC put an oil embargo on many Western countries over their support for Israel during the Yom Kippur War. This created a structural price shock that resonated through the economy that wasn’t effectively addressed by government of the day.
Two trends in the current economy point to this problem: Jobs data that’s weakened and missed economists estimates, and inflation that’s picked up and come in hotter than predicted.
January consumer inflation came in hot. Employers added far fewer jobs in February than in January, unemployment claims were worse than expected, and the staffing measure in the ISM manufacturing survey also showed a big jump in prices paid. On March 7, payroll numbers for February will add another data point — and some economists also expect a big miss.
And the Atlanta fed is now projecting a 2.8% contraction in the U.S. economy this quarter — an outlier given most analysts are still projecting growth, but a troubling sign of potential trouble.
During the 1970s stagflation, both stocks and bonds suffered. The benchmark S&P 500 plunged 48% between January 1973 to December 1974, and didn’t fully recover until the 1980s as profit growth lagged. Bonds also fell because their regular, fixed payments to investors were eroded by inflation.
Investments to cope with stagflation include inflation-protected investments like the U.S. government’s TIP bonds and upstream natural resource companies, Katie Nixon, chief investment officer at Northern Trust Wealth Management (NTRS+1.08%), told Kiplinger’s last year.
There’s no clear consensus on why stagflation ended and which government actions were actually effective in addressing the problem — many assessments track the ideological biases of the commentators.
While economic growth did rebound in the late 1970s, price gains remained faster than average until the so-called Volcker shock of 1979-1981, when the Fed gradually raised its key rate to as high as 19.1% in June 1981. This boosted the unemployment to a peak of 10.8%, but did bring CPI down to as low as 2.5%.
One reason a full repeat of 1970s stagflation isn’t likely in the U.S.: The country no longer has a strong labor movement. Unions were then strong enough to demand pay increases that matched inflation. Companies would boost their prices to cover the increased costs, creating a so-called wage-price spiral.
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