Last updated: October 17, 2026
- How stagflation works
- The 1970s US example
- Stagflation and the stock market
- Why stagflation is hard to fix
- Stagflation vs deflation and how investors respond
- FAQ
- Related terms
How stagflation works
Normally, high inflation occurs when demand is strong and the economy is running hot, while weak economies tend to see slowing price increases. Stagflation breaks that pattern: prices keep rising even as output stalls and joblessness climbs. It often stems from supply shocks, such as a sudden jump in energy costs, that raise prices across the economy while reducing production. Expectations of ongoing inflation can then become self-reinforcing through wages and pricing decisions.
The 1970s US example
The best-known case is the United States in the 1970s, when oil price shocks, loose monetary policy, and entrenched inflation expectations coincided with weak growth and high unemployment. The Federal Reserve under Paul Volcker eventually raised interest rates sharply around the end of the decade and into the early 1980s. Inflation came down, but the policy contributed to a deep recession, illustrating the painful tradeoff stagflation creates for policymakers.
Stagflation and the stock market
Stagflation is difficult for stocks because it squeezes earnings from both sides: input costs rise while sales volumes weaken. Higher interest rates also reduce the value investors place on future profits, pushing down valuation multiples such as the P/E ratio.
Suppose a company earns $5 per share and trades at 20 times earnings, or $100. If stagflation trims earnings to $4.50 and investors will only pay 13 times earnings, the price falls to about $58, even though profits declined only 10%. Fixed-rate bonds also suffer because inflation erodes the real value of their payments.
Why stagflation is hard to fix
Central banks usually fight inflation by raising interest rates, which slows borrowing and spending. During stagflation, that medicine worsens the growth problem and can push unemployment higher. Cutting rates to support growth, on the other hand, risks letting inflation become more entrenched. Government spending increases can boost demand but may add to price pressures. Because there is no painless option, policymakers often must choose which problem to address first. Supply-side improvements, such as easing energy constraints or boosting productivity, can help but usually take time to work.
Stagflation vs deflation and how investors respond
Stagflation is in some ways the opposite of deflation, where prices fall along with weak demand. During stagflationary periods, some investors have looked to real assets such as commodities, energy producers, inflation-protected securities, or companies with strong pricing power. Results vary, and no asset reliably protects a portfolio in every inflationary episode.
Frequently asked questions
What causes stagflation?
Stagflation is often triggered by supply shocks, such as sharp increases in energy prices, combined with policies or expectations that allow inflation to become entrenched while growth slows.
How is stagflation different from a recession?
A recession is a broad decline in economic activity and often comes with easing inflation. Stagflation pairs weak growth and high unemployment with high inflation.
What investments do well during stagflation?
Historically, some real assets and commodity-related investments have held up better than many stocks and bonds, but outcomes vary and no investment is guaranteed to perform well.
Related terms
← Spread · All terms A–Z · Stock Market Holidays →
For information only, not investment advice. See the disclaimer.