What Is Stagflation and How Can You Prepare for It?

What Is Stagflation?

Stagflation, a word popularized in the 1970s, is an economic event marked by high unemployment, slow growth and sharply increasing consumer prices. There's little consensus on what exactly causes stagflation because it doesn't happen very often.

Back in the mid-1970s and early 1980s, interest rates spiked as the Federal Reserve sought to combat inflationary pressures that saw steeply rising prices, particularly in the energy sector. With inflation hitting 14.6% in 1980, the Fed boosted its target federal funds rate to a record high 20%, spurring a recession. Prices were high, interest rates were high, and so was unemployment. While surges in inflation are common during periods of economic expansion, stagflation—where prices surge during economic downturns—is rare.

The pain this confluence of factors causes consumers is illustrated by the Misery Index. The Misery Index is calculated by adding the inflation rate to the unemployment rate. By using the index, economists can measure slumps in spending and household wealth, paired with a rise in mortgage rates, to evaluate how much the average person might be struggling.

What Causes Stagflation?

Economists look back at past examples of stagflation for insight into the factors that can lead up to such an event. Although there is no real consensus about its causes, some of the key triggers include:

• Rising oil prices: An increase in gas prices, which consumers experienced in the late 1970s and early 1980s and more recently in 2021 and 2022, leaves less room in people's budgets for discretionary spending and can increase the reliance on debt.
• Supply shocks: When changes occur in the availability of a product, the price usually increases or decreases. This can put a lot of strain on consumer wallets, especially if prices are increasing on necessities, such as food.
• Economic policy: Creating a policy that makes production costlier and less profitable while growing the money supply too quickly could have repercussions on supply and, as a result, the price of goods.

Why Is Stagflation Bad?

Generally, people are more financially stable when the economy is booming and prices and unemployment are low. But lately, the global economy has experienced inflation rates not seen in a very long time, leading some to warn of possible impending stagflation. However, the unemployment rate remains at a low 3.5% as of publication, which eases some experts' concern about stagflation.

Even so, many economists thought 2022 would be a period of strong economic growth as businesses reopened their doors and consumers spent their accumulated savings. But reality has brought rising inflation rates that have exceeded all predictions, and slow economic growth that has led to an increase in economic distress even with encouraging economic signs.

When high inflation and the fear of a recession occur in combination, the increased cost of goods and the fear of joblessness can put tremendous pressure on consumers. This may cause many to put off spending on certain items, further increasing the risk of stagflation and potentially worsening the general economy's health.

How to Prepare Your Finances for Stagflation

While it's difficult to predict with any certainty whether or not recession or stagflation will impact you personally, it's never a bad idea to start building financial resilience now by following these steps.

1. Improve Your Credit

Making all of your debt payments on time and avoiding carrying credit card balances from month to month are just two ways to improve your credit. Good credit can help because if an emergency strikes and you don't have enough funds in your emergency or sinking fund, you are more likely to qualify for a loan, home equity line of credit (HELOC) or another funding option.

2. Reduce Spending

Carefully consider what you need versus what you want to help you hold on to more cash during uncertain times. Plan ahead in case your car breaks down, your rent goes up or your employment becomes unstable. Reducing how much you spend each month means more money in the bank for necessities or emergencies.

3. Pay Down Debt

Paying down or paying off debt can go a long way in ensuring a more stable financial future. If you can, try to pay more than the minimum due each month on credit card or loan balances, or consider consolidating high-interest debt into one manageable payment instead of several.

4. Buffer Emergency Savings

A good rule of thumb for savings is having enough funds in your account to cover three to six months' worth of living expenses. Consider setting a savings goal, moving money from one account into savings automatically, or using a savings-focused app like Qapital that rounds up your change to the nearest dollar and moves it into your savings account automatically.

5. Find Additional Sources of Income

Sometimes a little creativity can lead to extra sources of income. Things like using a cash back credit card that lets you earn cash back when you shop, finding a side gig, renting out your house while you're away as an Airbnb or driving for Uber for a few hours each week can help you prepare for stagnation if it hits.

6. Don't Try Timing the Market

Timing the market means buying and selling stocks and securities based on market changes with the hope of minimizing your losses or increasing your gains. But without a crystal ball, it's pretty difficult to know just when the best time is to buy or sell. Instead, if you invest equal amounts at a regular cadence in a 401(k), IRA or other tax-advantaged investment option, you'll likely have better luck stashing money away for a rainy day.

The Bottom Line

Although the onset of stagflation can't be ruled out, preparing for it now and setting some money aside today can save you a lot of headaches if times do get tough. Monitoring your credit through Experian and staying vigilant regarding your overall debt today can help you improve your long-term financial health so you can weather any storms that may come your way.