Typically, stagflation happens when a country’s economic growth slows, demand falters, and unemployment rises despite climbing inflation.  

Because unemployment rarely supports growth, and when demand nosedives, so can inflation. However, this is out of the ordinary as businesses would likely drop investments because the consumers are spending less and/or have limited amounts of money for purchases. 

Concepts like this are at the heart of the theory called the ‘Phillips curve,’ which shows that as unemployment falls, inflation should rise, and vice versa. But these theories would fall on its face in stagflation conditions.  

During these times, the prices of goods and services increase while economic growth remains sluggish and unemployment rates rise. Prices are rising, and purchasing power doesn’t keep pace.

Typically, a slow economy would reduce the demand for goods and services, driving prices down. However, stagflation’s dual characteristics compound each other.

Stagflation poses a conundrum for the world’s central banks, including the U.S. Federal Reserve. The Fed normally cuts interest rates to boost economic activity and reduce unemployment. But doing so during stagflation would theoretically send inflation higher. The Fed finally contained the 1970s inflation by raising interest rates sharply from 1979 through 1983, but their actions also pushed the economy into another recession.

Once stagflation arrives, that conundrum causes it to linger, creating the dual challenges that squeeze businesses large and small: low or negative economic growth, which means softening customer demand, while costs rise from inflation.

The advent of stagflation across the developed world later in the 20th century showed that this was not the case. Stagflation is a great example of how real-world experience can run roughshod over widely accepted economic theories and policy prescriptions.

Since that time, inflation has proved to be persistent even during periods of slow or negative economic growth. In the past 50 years, every declared recession in the U.S. has seen a continuous, year-over-year rise in consumer price levels.

How Stagflation Affects Small Businesses

• Rising Prices

Small businesses are paying more for supplies, utilities, and financial obligations. Those costs are passed on as higher consumer prices, as businesses are forced to raise prices. It’s a trade-off.

• Spiking Oil Prices

The rise in the prices of oil and gasoline/diesel has reached historic levels. The rate of inflation for oil and gasoline/diesel has been staggering. The country is facing an oil crisis, with the winter months to come.

• Unemployment

Although unemployment rates are decreasing, the nation is still about 2 million jobs short of pre-pandemic employment levels.

Stagflation weighed heavily on the US through the 1970s, and there have been concerns that it may reemerge as the economy recovers from the pandemic-induced recession.

Economists are closely watching the trends in growth, unemployment, and inflation along with the potential catalysts that could trigger stagflation including supply disruptions and central bank policies. Persistently high energy prices have caused particular concern among some. 

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