What Is Stagflation? How To Invest in a High-Inflation, Low-Growth Economy

You’ve likely heard a lot about inflation over the past couple of years. It spiked in 2022 — the highest level since 1981. But at the same time, economic growth fell, which created a unique economic environment.

These two factors led many to worry about something called “stagflation.” The word is a combo of these two situations: a stagnant economy with high inflation. 

But how does it work? And more importantly, what does it mean for you and your money?

. . .

What Is Stagflation?

Stagflation is an economic condition characterized by both a stagnant economy and high inflation.

This is an unusual phenomenon because of the historical relationship between economic growth, unemployment, and inflation. 

Typically, when economic growth is low, the unemployment rate tends to rise. This is something known as Okun’s law. Meanwhile, high unemployment is typically associated with low inflation — this is known as the Phillips curve.

So, we expect periods with low economic growth to have high unemployment and low inflation. It’s uncommon to have low growth and high inflation simultaneously. 

Example of Stagflation

The only recorded instances of stagflation in the U.S. were from 1967 to 1982 — specifically in the mid-1970s and early 1980s. During this period, inflation reached a high of nearly 15%.

Meanwhile, the unemployment rate reached 9% in the mid-1970s, fell, and then soared again to nearly 11% in the early 1980s as the Federal Reserve fought inflation. 

During this period, the U.S. economy suffered four separate recessions. The average annual inflation was over 6.5%, and the average unemployment rate was over 6%. 

How the government reacts to stagflation

When Paul Volker took over as chairman of the Federal Reserve in 1979, he recognized that fighting unemployment could worsen inflation, while fighting inflation could worsen unemployment. 

However, he determined that fighting inflation took priority — even if it meant a short-term worsening of the economy.

In 1980-1981, the federal funds rate (which had been below 5% a few years prior) peaked close to 20%.

As expected, unemployment spiked, reaching nearly 11% in 1982. But it then fell below 7.5% less than two years later, and by the late 1980s was near 5%. Unemployment didn’t rise past 8% again until the financial crisis in 2009.

And the inflation rate stayed under 5% for nearly all of the following 30+ years. 

How To Prepare for Stagflation

The purpose of all this history is to give you context on what you should do if there are warning signs of stagflation, to maintain your own financial stability. 

Build up your savings

Since stagflation goes hand-in-hand with high unemployment, it’s important to prepare for a tough job market and potential loss of income.

Set up an emergency fund if you don’t have one already. An emergency fund should ideally cover about six months of income — although we know this can be tough to do if you’re living paycheck to paycheck. 

Set aside what you can, ideally in a high-yield savings account, so that you can earn interest on whatever money you put in there.

You could even consider taking on a side hustle — something that you can fall back on if your job is hit.

READ MORE: How Much Should You Save a Month?

Pay down your debt

Again, this might be easier said than done, but if you can afford to put more money against your debt, do it. 

Remember, stagflation comes with high inflation, which typically also means high interest rates. If you have debts with variable interest rates (think: credit cards, variable-rate loans), you could end up owing even more should those rates jump.

Reduce your debt as much as you can and avoid charging any new debts. Also, since high interest also applies to savings accounts, this is even more reason to put your extra money into the bank — rather than buying something you don’t absolutely need.

READ MORE: How To Pay Off Credit Card Debt

Best Investments During Stagflation

Stagflation periods have low growth and high inflation, and the Federal Reserve’s strategy to fight inflation is typically to raise interest rates. So, you’ll want investments that can thrive in such an environment. 

Goldman Sachs Asset Managers recommends three investment categories to navigate stagflation: real estate, value equities, and bonds.

1. Real estate

Poor economic growth and elevated interest rates can make homes less affordable. 

Banks consider your debt-to-income ratio to determine how much you can afford in mortgage payments — and higher interest rates reduce how much you can put toward the loan’s principal each month. Plus, a slower economy may mean you have fewer liquid assets to put toward a down payment. 

If you are fortunate enough to have savings and a job to withstand stagflation, you may be able to purchase real estate at a discount and then benefit from its increased value when the economy recovers and interest rates fall. 

2. Value equities

While a poor economy may harm most stocks — the S&P 500 index fell more than 50% during the financial crisis — growth stocks may be hit particularly hard during these times. 

Growth stocks are stocks that have the potential to rapidly increase in value. They’re often startups and tech companies that have a lot of buzz, but not necessarily a proven track record yet.

Popular growth stocks may rely on debt financing before they hit profitability, and the cost of that debt may increase substantially during stagflation. The same is true of speculative investments into unprofitable companies. 

Value stocks, on the other hand, are undervalued or trading for less than what they are worth. With these investments, you’re looking for things like positive cash flow and proven profitability. They’re less exciting than growth stocks, but also less risky.

3. High-quality bonds

In 1981, investors could have locked in nearly 15% APY with 30-year Treasury bonds — risk-free returns that even beat the stock market, which only returned less than 12% annually from 1982 to 2012.

Plus, the price of those bonds would have soared as rates fell, so investors could have sold for a meaningful profit without holding onto the bonds for the entire period. 

Municipal and corporate bonds could also be an option. Companies that issue bonds will have to do so at higher APYs to account for the elevated risk of default. 

If you invest in high-quality companies that can navigate a poor economy, you could be rewarded with higher yields, followed by strong returns once the economy improves and rates eventually fall. 

READ MORE: What Are Bonds and How Do They Work?

Stagflation vs. Recession 

Stagflation and recessions are two economic situations characterized by poor economic growth. 

A recession has a very specific definition: two periods of negative GDP growth. However, there is no requirement for prices to behave a certain way to define a recession. In fact, after the stagflation period of the ‘70s and the inflation-fighting period in the early ‘80s, prices tended to fall throughout recessions. 

For example, you can see in this chart how inflation turned negative by the end of the financial crash and had fallen to near zero in April 2020 when Covid-19 brought the economy to a halt. 

Stagflation is far rarer than a recession and generally considered worse. While the economy doesn’t need to have two consecutive periods of negative growth to be “stagnant,” the 15 years of stagflation from 1967 to 1982 included four distinct recessions. 

And the fight against inflation in the early ‘80s drove unemployment up. GDP fell by nearly 2% in 1982, marking the fourth year between 1974 and 1982 to have negative annual GDP growth.

The last period of stagflation consisted of four distinct recessions. However, the past four recessions did not turn into stagflation as prices tended to fall during those periods. 

TL;DR

Stagflation is an economic term that refers to a period of low growth, high inflation, and high unemployment. It’s a risky period for your finances, but thankfully not as common as a recession. 

And there are ways to prepare, like paying down as much debt as possible and putting any extra money you have into a high-yield savings account. 

For more tips on managing your money and investments, check out these episodes of the Erika Taught Me podcast:

• Investing Advice from the Most Powerful Woman on Wall Street
• How To Become Better With Money
• Money & Investing Pitfalls To Avoid