Stagflation: high inflation, weak growth and the 1970s lesson

Stagflation is the combination of high inflation with stagnant or falling output and rising unemployment. The word joins "stagnation" and "inflation," and for much of the 20th century economists thought the pairing was unlikely: inflation was supposed to be a symptom of an economy running too hot, and unemployment a symptom of one running too cold. The United States in the 1970s had both at once, for years.

Stagflation matters to investors because it attacks both halves of a stock's value at the same time. Weak demand squeezes earnings, while high inflation pushes interest rates and the discount rate up. Bonds suffer too, because inflation erodes fixed payments. This page explains what stagflation is, walks through the 1965–1985 record in the data, looks at how policy finally broke it, and shows why 2022, despite the highest inflation in four decades, was a different animal.

What stagflation is

For a few decades after World War II, the pattern economists expected was a trade-off: when unemployment fell, inflation tended to rise, and vice versa. The relationship is named the Phillips curve. In the 1960s policymakers widely believed it was a stable menu: accept a bit more inflation and you could buy a bit less unemployment.

Stagflation is what happens when that menu breaks. Inflation rises and unemployment rises together. Two broad forces can do it:

• Supply shocks. A sudden jump in the price of something the whole economy uses, most often energy, raises costs everywhere (inflation) while draining spending power from households and businesses (weaker output). The central bank faces a dilemma: fight the inflation and deepen the slump, or support growth and let inflation run.
• Unanchored expectations. If workers and firms come to expect high inflation, they build it into wages and prices. Inflation then persists even when the economy weakens. In the late 1960s the economists Edmund Phelps and Milton Friedman argued that this would happen, and that any Phillips-curve trade-off could last only until expectations caught up.

The 1970s had both forces at work, which is why the episode lasted so long.

The 1965–1985 record

The chart shows the two series the textbook said should move in opposite directions. They don't. The Federal Reserve's history of the period dates the "Great Inflation" from 1965 to 1982. In the data it unfolds in four stages.

1965–1969: overheating. CPI inflation was 1.1% in January 1965. By December 1969 it was 5.9%, with unemployment at just 3.5%. This is the classic Phillips-curve pattern, a tight labor market and rising prices, and not yet stagflation.

1970–1975: the first wave. The 1969–70 recession pushed unemployment to 6.1% by December 1970, yet inflation was still 5.6% that month. Then came the 1973 oil embargo, which the Fed's history says roughly quadrupled crude prices. Energy prices in the CPI were up 33.7% from a year earlier by September 1974. Headline inflation peaked at 12.2% in November 1974, and the 1973–75 recession, 16 months long, lifted unemployment to 9.0% in May 1975, when inflation was still 9.3%. Real GDP fell at annual rates of 3.7%, 1.5% and 4.8% in the three quarters to early 1975.

1976–1980: the second wave. Inflation eased to 5.0% by December 1976 but never returned to 1960s levels, and unemployment stayed high, at 7.8% that month. After the 1979 oil shock, which the Fed's history says roughly tripled oil costs, energy CPI was up 47.2% year over year in March 1980, and headline CPI inflation peaked at 14.6%. Inflation excluding food and energy was 13.6% in June 1980, so this was not just an oil story: prices across the economy were rising fast.

1979–1985: the cure. Paul Volcker became Fed chair in August 1979, and in October 1979 the FOMC said it would target the growth of bank reserves rather than the federal funds rate, letting short rates go wherever that required. The effective fed funds rate averaged 19.1% in June 1981 and the 10-year Treasury yield 15.32% in September 1981. Two recessions followed in quick succession, January to July 1980 and July 1981 to November 1982. Unemployment peaked at 10.8% in November and December 1982. Inflation fell to 3.8% by December 1982 and to 2.4% in July 1983.

Why policy struggled

Stagflation is hard because the usual tools pull in opposite directions. Raising rates fights inflation but weakens employment further; cutting rates supports employment but feeds inflation. In the 1970s the Fed leaned toward supporting growth for long stretches, and real interest rates (the policy rate minus inflation, see Real interest rates: nominal rates minus inflation, explained) were often negative: the effective fed funds rate was below CPI inflation in 63 months between November 1970 and September 1980. In December 1974 the gap was −3.6 percentage points.

Other tools were tried. The Fed's history notes wage and price controls introduced in three phases between 1971 and 1974; inflation returned once they were lifted. What finally worked was keeping real rates high long enough to change expectations: by June 1981 the real fed funds rate, on this measure, was +9.4 points, the highest in the data. The cost was the deepest unemployment of the post-war era until 2020. The Fed's tools and choices today are covered in The Federal Reserve: structure, mandate and policy tools and How Fed decisions move markets: expectations, surprises and yields; the policy mix with government spending and taxes is in Fiscal vs monetary policy: who controls which lever.

How stagflation hits markets

Stocks. In normal recessions, falling inflation and rate cuts soften the blow to stock prices. In stagflation that cushion disappears: earnings fall in real terms as demand weakens and costs rise, while the discount rate stays high or rises. Both parts of the valuation in How the economy affects stocks: growth, inflation, jobs and rates work against the price at once. Companies that can pass costs on, such as some energy and commodity producers, can do better than the rest (see How sectors behave across the business cycle: cyclicals vs. defensives).

Bonds. Bonds pay fixed amounts, so inflation erodes them directly. When yields rise to compensate, existing bond prices fall (see Bond prices and yields: why prices fall when yields rise). The 10-year Treasury yield went from 7.43% in December 1974 to 15.32% in September 1981. Inflation-protected bonds, which did not exist in the US until much later, are covered in TIPS and breakeven inflation: how inflation-protected bonds work.

Cash. Short-term rates eventually rose above inflation, but for long stretches of the 1970s they lagged it, so cash lost purchasing power too.

That combination, stocks and bonds hurt together, is why stagflation is the scenario diversified portfolios fear most: the usual offset between the two breaks down.

Was 2022 stagflation?

Not in the 1970s sense. CPI inflation was 9.0% year over year in June 2022 (the seasonally adjusted series; the not-seasonally-adjusted headline BLS reported was 9.1%), the highest on this series since November 1981. But unemployment was 3.6% that month, payrolls grew by an average of 377,000 a month during 2022, and no recession was dated. Rising inflation with a tight labor market is the overheating pattern of the late 1960s, not stagflation. Stocks and bonds did fall together in 2022, for the discount-rate reason, which is the part of the stagflation playbook that showed up (see The 2022 bear market: inflation, Fed hikes and falling bonds and How interest rates affect stocks: discount rates and equity duration).

A rough screen makes the point. Counting months in which CPI inflation was at least 5% and unemployment at least 6%, the data have 84 such months between December 1970 and October 1982, and only 6 since 1986 (five in 1990–91 and one in August 2008). There are none in the 2020s, including 2026 so far: in September 2026 CPI inflation was 3.7%, core inflation 2.6% and unemployment 4.2%, with energy prices in the CPI up 20.4% from a year earlier. The thresholds are ours and arbitrary; they show the shape of the record, not an official definition.

Pitfalls when people say "stagflation"

• Any inflation plus any slowdown is not stagflation. The term is used loosely in headlines. Ask whether inflation is high and unemployment is rising and output is weak, and for how long.
• Headline versus core. An energy spike can lift headline inflation for months while core inflation (see Core inflation: why food and energy are left out) stays moderate. In 1980 both were in double digits, which is what made it entrenched.
• The past is not a template. The 1970s had specific features: an exchange-rate system breaking down, two oil shocks, wage-price controls, and policymakers who, in the Fed's own published history, treated the inflation-unemployment trade-off as stable. A new episode would differ.
• No forecast here. Elevated inflation readings today do not imply a repeat. The data on this page describe what happened, not what will.

Stagflation and its neighbors

See Inflation: what it is, how it’s measured and what it does to money for how inflation is measured and Stagflation for the short definition.

How Finabase does it

Finabase does not publish inflation, unemployment or GDP data, and the app has no economic calendar. The 1965–1985 chart on this page is ours, drawn from public BLS data.

The market prices most sensitive to stagflation risk are in the app. The futures list carries crude oil, natural gas, gasoline, gold and other commodity contracts, including WTI crude and gold. The Treasury table shows yields from 1 month to 30 years, and the sector page shows whether energy and other cost-passing sectors are outperforming. For coverage of inflation releases and Fed decisions, Discover has Fed and economy topics.

Frequently asked questions

What is stagflation in simple terms?

It is a period when prices are rising fast while the economy is stagnant and unemployment is rising. Normally high inflation comes with a strong economy and weak growth with low inflation; stagflation is when the bad halves of both arrive together.

What caused stagflation in the 1970s?

A mix of forces: inflation that had been building since the late 1960s and became embedded in expectations, two oil shocks in 1973 and 1979 that sharply raised energy prices, and monetary policy that kept real interest rates low or negative for long periods. It ended after the Fed held rates very high from 1979 to the early 1980s.

How is stagflation fixed?

Historically, by bringing inflation down first, which in 1979–82 meant very high real interest rates and two recessions. Once inflation expectations fell, growth recovered without the same price pressure. There is no painless cure on the record.

Is stagflation bad for stocks?

Usually, yes, because earnings come under pressure while interest rates and the discount rate stay high, so neither part of a stock's value gets support. Bonds tend to suffer at the same time, which makes it hard to diversify.

Summary

Stagflation is high inflation together with weak growth and rising unemployment, a combination the post-war Phillips-curve view treated as unlikely until the 1970s made it the norm. In the US data, inflation rose from 1.1% in 1965 to peaks of 12.2% in 1974 and 14.6% in 1980 while unemployment climbed as high as 9.0%, driven by entrenched expectations and two oil shocks. It ended only after the Fed pushed real rates sharply positive and the economy went through the 1981–82 recession. For markets it is the hard case: earnings and the discount rate both work against stocks, and inflation hurts bonds too. High inflation alone, as in 2022, is not stagflation.