By Matija Šerić
Economics is a complex social science consisting of symbols, numbers, concepts, algorithms, and other variables. However, one does not need to be a trained economist to understand the danger of certain economic conditions. Most people are aware of the dangers of inflation—the general rise in prices of goods and services—but only a minority understand the phenomenon that logically follows inflation. This is stagflation, one of the most negative economic phenomena, euphemistically speaking. In reality, it is a hurricane-like threat capable of completely devastating an entire economy. Stagflation causes nightmares not only for ordinary people but also for politicians who must try to tame it.
Definition
The term emerged in theory during the 1960s in the United Kingdom. Definitions of stagflation vary slightly, but most economic institutions agree that it is a state of the economy characterized by persistent inflation, high unemployment, and slow (stagnant) economic growth, while production in many cases declines. High prices for essential goods, waves of layoffs, reduced wages or unpaid work, and decreased production capacity drive ordinary people into despair, hopelessness, and apathy. It is a situation that no one wants to experience, and it is even harder to fix. Stagflation sooner or later leads to a recession—a state in which GDP falls for at least six months, along with trade and production volumes.
Prevention
Stagflation can be prevented through prudent economic policy by the national government. The government’s monetary policy must ensure that the central bank issues limited amounts of money, imposes higher interest rates to curb excessive credit and unnecessary investments. This helps suppress inflation. Furthermore, fiscal policy should involve raising taxes or cutting public spending, reducing consumer demand. Producers should be encouraged to innovate, which can be achieved through research. The government should assist companies in achieving cost-effective operations. Support for small and medium-sized enterprises and the implementation of infrastructure and other employment-generating projects are desirable. This will help guide the economy onto a positive path in the long term.
Rare but extremely destructive phenomenon
Stagflation is rare in reality, but when it occurs, it often defies the predictions of many economic experts. Why? Because most economists claim that inflation is caused by increased economic spending, while falling prices lead to recession. Yet reality sometimes differs greatly from textbook explanations. In stagflation, the sequence of events is reversed.
Stagflation first appeared in the real world in the 1970s during the oil crises triggered by the Yom Kippur War in 1973 and the Iranian Revolution in 1979. In 1973, stagflation was caused by the Arab oil embargo imposed on the U.S. and other Western allies of Israel, and six years later, it was triggered by a drop in Iranian oil exports following the revolution. Oil shortages in global markets (shortages in the West) sent crude prices skyrocketing, while factories lacked materials for production or funds to buy raw materials. Additionally, the already weakened dollar further lost value. Many workers were laid off. Inflation became an everyday reality for Americans, Europeans, Indians, Japanese, and other nations.
During the 1980s, stagflation hit Latin American countries, including Brazil and Argentina. These nations fell into debt crises, unable to repay accumulated foreign loans: hyperinflation ensued, accompanied by mass layoffs and reduced industrial production. Stagflation often emerges in developing countries in Africa and Asia, with triggers including the 2009 global financial crisis and the 2020 COVID-19 pandemic.
A very dangerous phenomenon
The misery index measures a hard-to-solve challenge
Stagflation is measured using the so-called Misery Index—the sum of the inflation rate and the unemployment rate. The stronger the stagflation, the higher the Misery Index, meaning fewer available jobs and reduced purchasing power for citizens. Conversely, when stagflation weakens, the number of jobs grows along with consumer purchasing power. As mentioned, once stagflation occurs, it is very difficult to eliminate because it defies traditional economic principles. It is harder to resolve than either inflation or recession. Policymakers try to reduce inflation by implementing tight monetary policy, i.e., raising interest rates, but this slows economic growth and leads to numerous layoffs. If they do this, stagflation worsens. On the other hand, if they increase public spending to support economic growth, inflation rises due to higher consumer demand. This action also worsens the stagflationary state.
Winners of stagflation
Although stagflation is undesirable for most, a minority benefits from it. These are corporations that profit if the prices of their products or services increase, mainly energy companies, high-tech industries, and manufacturers of specialized goods. Investors may also benefit by leveraging opportunities across multiple sectors, as money loses value, potential losses are smaller, and profits potentially rise.
The U.S. faces the risk of entering stagflation
A new wave of this negative phenomenon may be looming. As early as April this year, Federal Reserve Chairman Jerome Powell warned that the new Trump tariffs were “significantly higher than expected,” likely resulting in “higher inflation and slower economic growth,” classic precursors of stagflation. Many U.S. companies have already planned layoffs. If current trends continue, a wave of layoffs is inevitable. The economic policy of the Trump administration dangerously threatens the U.S. economic outlook.
Strict tariffs lead to higher prices for goods on global markets and in bilateral trade, which will sooner or later be felt by American consumers at the checkout. America has long been an importing country, buying many of its everyday products from China, the EU, India, and other nations. Last year, the value of U.S. imports amounted to $3.3 trillion, demonstrating the country’s deep integration into global trade. If stagflation truly occurs in the U.S. and other Western countries, it will be a very dangerous situation. The U.S., like other Western economies, is burdened with debt and low interest rates, making central bank operations more difficult.
Potential solution
There is no simple solution to this negative phenomenon. Experts generally recommend a coordinated application of supply- and demand-side measures: improving conditions for production and investment, raising interest rates, prudently controlling labor costs, and gradually strengthening consumer spending in targeted segments. This approach should allow the economy to regain positive growth, reduce inflationary pressures, and stabilize purchasing power for broad groups of citizens. But this is theoretical. Whether this formula works in practice depends on the specific case. Clearly, it is better to prevent stagflation than to treat it.
