Why You’re Hearing About Stagflation Right Now, and What You Can Do to Prepare for It

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With inflation over 8% and the threat of a recession on the horizon, there are global concerns about stagflation, a combination of low economic growth and soaring prices. 

But is it something the average American needs to be concerned about?

“At this point, we can’t say that we’re yet in a period of stagflation,” says Lindsey Piegza, chief economist at Stifel Financial, a financial investment firm. However, given the current economic situation, “it is a very real risk.” 

The Federal Reserve is in the process of raising interest rates to combat inflation that’s coming in at 40-year highs month after month. If the Fed’s aggressive interest-rate policy forces the economy into a recession and global supply chain disruptions put pressure on prices, we could see elevated prices at the same time the economy is slowing down, Piegza says.

Let’s take a look at what stagflation is, how it works and what you can do to minimize its impact on your life.

What Is Stagflation and How Can It Affect You?

Stagflation occurs when high inflation and slow economic growth happen at the same time. “The general notion of stagflation is high inflation and high unemployment,” says Elliot Eisenberg, chief economist at GraphsandLaughs, an economic consulting firm.

Although the prices of many goods and services are increasing, right now we are not experiencing stagflation because the economy is doing well and unemployment is low. In April, unemployment was 3.6%, almost exactly what it was before the COVID-19 pandemic. “This is certainly not yet stagflation,” Eisenberg says. However, given the potential supply shocks we could experience from events around the world, there is a risk we could enter a time of stagflation in the future.

During times of stagflation there is increased financial risk. The possibility of a loss in income increases with rising unemployment. And for the households that manage to keep their jobs, their purchasing power is eroded by the sudden increase of prices for everyday necessities.

“It’s a double whammy because you’re still paying higher prices for goods and services. But now at the same time, you have to contend with the effects of slower domestic [economic] activity,” Piegza says.

Pro Tip

Carefully consider large purchases, which may be more expensive right now. Delaying large non-essential purchases could help you pay off debt or build your emergency savings.

What Causes Stagflation and Are We Headed for It?

Stagflation isn’t common. When stagflation occurred in the 1970s it was brought on by a perfect storm of policy decisions that created rising inflation and geopolitical events that caused a supply shock for oil and impacted economic growth. “It was the result of a lot of bad policy decisions,” Eisenberg says. 

High government spending partnered with the Federal Reserve lowering interest rates low helped to increase the money supply and create sustained inflation during that time. Adding to that was rising energy prices brought on by the 1973 Organization of Petroleum Exporting Countries (OPEC) oil embargo and the oil shock of ’78-’79

That time period was marked by years of mismanagement, but “right now it’s different, right now we’ve got one bad year of inflation,” Eisenberg says.

Over the past two years the government has spent huge sums of money through multiple rounds of stimulus spending and the Federal Reserve has kept the federal funds rate low. This led to economic growth following the COVID-19 pandemic, but has also contributed to inflation, with the Consumer Price Index (CPI) touching heights we haven’t seen since the 1970s. But at the moment, the economy is still doing well and we are far from what would be considered as high unemployment.

Looking at the economy overall, the advance estimate for gross domestic product (GDP) in the first quarter of 2022 showed a 1.4% decrease in growth. However, both Eisenberg and Piegza don’t see this as cause for alarm. When you look at the GDP report, the weakness was not the result of a fundamental slowdown in economic activity, Piegza says. At the end of last year businesses stockpiled inventory, which contributed to high GDP growth in Q4 of 2021, Piegza says. “Now at the first quarter [of 2022], we see a reversal of that because businesses are still eating through that existing stockpile.” If you factor this, it would show the economy is still growing, Piegza says.

However, there is a large degree of uncertainty, and the threat of economic stagnation is real. The Russian invasion of Ukraine and the renewed COVID-19 lockdowns in China threaten to further disrupt supply chains, raise energy prices and impact economies around the world. And inflation still isn’t under control.

How to Combat Stagflation

Even if we don’t enter a period of stagflation, slow growth in the economy isn’t out of the question.

The Federal Reserve is raising interest rates to fight inflation and in the past that has increased the chances of a recession, according to Eisenberg. It’s going to be a really dicey situation and the chances of the Fed getting it wrong are high because they don’t know the future, he says. 

Although the future is uncertain, there are precautions you can take. For example, it’s not wise to panic and sell off your investments. Instead, take this time to assess your strategy and refocus on the fundamentals, such as saving and diversification.

Pay Attention to Your Spending & Saving

Take the time to establish a budget and prioritize your spending and saving to align with your most important financial goals. 

If you’re in a position to delay expensive purchases, you may want to consider it. “The market’s telling me don’t buy the car, don’t buy the camper, don’t buy that stereo system, or whatever it is, and ultimately it’ll get cheaper down the road,” Eisenberg says.

Consider using the money you’re not spending to pay down debt or build up your emergency fund. Experts differ on how much savings you should have, but starting now will put you in a more secure position later.

Look for Ways to Increase Your Income

As the costs of housing, gas and food go up, even if your income stays the same you’ll have less leftover at the end of the day. “Wages aren’t keeping up with inflation,” Eisenberg says. “Real incomes are declining.”With unemployment so low, “firms are desperate to hire,” Eisenberg says. Look into finding a better paying job or negotiating a higher salary with your current employer. If you’re not in a position to negotiate for higher pay or find a new job, you can diversify your income in other ways. There are all sorts of profitable side hustles you could dip your toes into this year.