Learn which three economic conditions create stagflation and how to protect your finances if it occurs.

Inflation is a common topic on broadcasts, podcasts and Substacks, and recently it has been paired with another economic concern: stagflation. Here’s a look at what it is, what contributes to it and how you can protect yourself from stagflation.

What is stagflation?

Stagflation describes an economic environment in which inflation, stagnant economic growth and high unemployment occur simultaneously.

For individuals and families, stagflation means the cost of living rises faster than their ability to pay. Inflation results in higher prices for everything from groceries and rent to transportation and medication. Pay doesn’t rise enough to keep pace with higher costs. Those who lose their jobs often face increased competition for fewer available positions. It’s tough all around.

Stagflation vs. recession

Stagflation is not the same as recession.

Recessions are part of normal business cycles. They’re triggered by specific events or market conditions that vary from financial bubbles to interest rates to unforeseen events like the Covid pandemic. Past recessions have been relatively short-lived, just one or two months, but some have lasted up to 18 months. Most end after one year.

Stagflation, with its triple whammy of inflation, economic stagnation and high unemployment, is a much more difficult condition. And, it may last significantly longer, from three to ten years. The stagflation of the 1970s—largely a result of years of climbing inflation followed by the  1973 OPEC oil embargo and the Iranian Revolution in 1979 both of which contributed to oil shortages—lasted until 1982.

What causes stagflation?

Economic shocks are the driver of stagflation in the view of many economists. “When significant economic shocks reduce an economy’s productive capacity while simultaneously raising costs, both inflation and unemployment can rise together,” according to Investopedia.

Economic shocks can result from:

• Supply shocks
• Fiscal policies, including tariffs and interest rates
• Unanchored expectations that do not align with economists’ forecasts

How do policymakers address stagflation?

“[S]tagflation is hard to combat with the usual policy tools,” the Federal Reserve Bank of Cleveland says. “Federal Reserve policymakers typically address slower economic growth or higher unemployment by cutting interest rates. But cutting interest rates can lead to higher inflation. On the other hand, the Fed typically responds to higher inflation by raising interest rates. But raising interest rates can slow economic growth and increase unemployment.”

So what do policymakers do? “The Fed pays close attention to economic data and carefully weighs risks to the outlook for inflation and employment when setting interest rates in order to promote our two goals, stable prices and maximum employment,” according to the Federal Reserve Bank.

What stagflation means for consumers

Stagflation affects consumers on many fronts and can lead to financial hardship. In addition to a higher risk of unemployment, wages stagnate and purchasing power decreases. Savings can dwindle when money buys less than it used to as many people dip into their savings. At the same time, buying on credit may get more expensive if central banks raise interest rates to address inflation.

How can you protect yourself from stagflation?

Clearly, personal budgets are strained during stagflation. Having 3 to 6 months of living expenses in savings provides a financial buffer in case of a loss of income and rising prices. Save money in a dedicated emergency fund so you’re not tempted to use it for other things. If you haven’t already started saving, start small and build your balance over time. Even $500 can make a difference during unexpected events.

If you already have up to six months’ worth of expenses in savings, consider building your emergency fund to cover up to 12 months of living expenses for additional financial security.

Another way to strengthen your personal finances is to review your spending and eliminate unnecessary purchases. Review recurring expenses and cancel subscriptions and memberships you no longer use or that duplicate others you use more. Comparison shop for insurance and mobile phone services.  When you find opportunities to reduce expenses, deposit those savings in your emergency fund.

 

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