In normal economic cycles, inflation and unemployment move in opposite directions: a strong economy pushes prices up but keeps unemployment low; a weak economy cools inflation but raises unemployment. This relationship — the Phillips Curve — was the foundation of post-war economic policy. Stagflation broke the model entirely.
The stagflation dilemma, visualised
The 1970s: the defining stagflation episode
Stagflation first emerged in the 1970s when two oil shocks (1973 OPEC embargo, 1979 Iranian revolution) hit economies that were already running hot from loose monetary policy. Oil is an input to almost everything — when it quadruples in price, costs rise throughout the economy while real incomes fall, reducing spending and growth simultaneously. The result: double-digit inflation alongside rising unemployment in the US, UK, and most of Europe.
How was it solved?
Ultimately, Fed Chairman Paul Volcker raised US interest rates to nearly 20% in 1981 — deliberately inducing a sharp recession to break inflation expectations. It worked, but at severe cost: unemployment hit 10.8%, the deepest US recession since the Great Depression. The UK's Thatcher government pursued similar policies. The lesson: once high inflation becomes entrenched in wage negotiations and price-setting, breaking it requires sustained pain.
What this means for you
Stagflation is rare but not impossible — it resurfaced as a concern in 2022 when energy prices surged after Russia's invasion of Ukraine, just as central banks were already behind on inflation. During stagflation, almost all assets struggle: stocks fall (lower growth), bonds fall (higher rates), and real assets like commodities and real estate can outperform. Protecting purchasing power becomes more important than maximising returns.