What is stagflation? The 1970s, its causes and how it differs from a recession

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Stagflation is a period of high inflation combined with weak or stalled economic growth and rising unemployment. The textbook case is the United States in the 1970s, when consumer prices rose 12.2% in the year to November 1974 and unemployment reached 9.0% in May 1975, and then inflation hit 14.6% in March 1980 before unemployment climbed to 10.8% in late 1982.

It is a hard combination to fix. The usual medicine for inflation, higher interest rates, slows the economy further, while the usual medicine for a weak economy, cheaper money, tends to push prices up. This guide covers where the word came from, what caused the 1970s episode in the US and UK, and how it ended.

Where does the word stagflation come from?

It joins "stagnation" and "inflation." The earliest use usually cited comes from the British Parliament. In a House of Commons debate on economic affairs on November 17, 1965, the MP Iain Macleod complained that Britain faced inflation and stagnation together, and said, as recorded in Hansard (column 1165): "We have a sort of 'stagflation' situation." At the time, UK industrial production was falling while incomes were still rising.

The word spread in the 1970s, when the problem Macleod described became severe on both sides of the Atlantic.

What is stagflation, exactly?

Stagflation has no official definition or threshold of the kind the NBER gives for recessions. In practice, the term is used when three things happen at once:

• inflation is well above normal and persistent;
• output grows slowly or falls;
• unemployment rises or stays high.

The Federal Reserve's history essay on the period describes it as an era when "both inflation and unemployment became unacceptably high." Before the 1970s, many economists relied on the Phillips curve, the observed tradeoff in which lower unemployment came with higher inflation. The essay notes that Edmund Phelps and Milton Friedman warned the tradeoff would not hold, and that the curve would shift upward as people came to expect inflation. The 1970s proved them right.

What caused stagflation in the 1970s?

The Federal Reserve history essay dates the "Great Inflation" from 1965 to 1982. Several forces combined.

Inflation was already rising

US consumer prices rose only 1.2% in the year to December 1964, with unemployment at 5.0%. Inflation then crept up through the late 1960s and early 1970s. By January 1973 it was 3.6%, before any oil shock. As Phelps and Friedman had warned, once people expect rising prices, wages and prices are set higher in advance, which keeps inflation going.

The first oil shock, 1973

In October 1973 Arab oil producers imposed an embargo that lasted five months, and crude oil prices quadrupled, according to the Fed essay. Higher energy costs pushed up prices across the economy while cutting what households could spend on everything else. The NBER dates a recession from November 1973 to March 1975, 16 months. Inflation peaked at 12.2% in November 1974, and unemployment peaked at 9.0% in May 1975, two months after the recession officially ended.

The second oil shock, 1979

The Iranian revolution in 1979 set off a second energy crisis, and oil prices tripled. This time inflation started from a higher base. By October 1979 it was running at 12.1%, and it reached 14.6% in March 1980.

Source: BLS consumer price index (CPI-U, seasonally adjusted index, 12-month change computed) and unemployment rate, via FRED series CPIAUCSL and UNRATE. Figures for the not seasonally adjusted index can differ by a few tenths.

For how price rises spread through an economy in general, see our page on what causes inflation.

How did Paul Volcker end stagflation?

Paul Volcker became Fed chairman in August 1979, when, in the words of the Fed's history essay, year-over-year inflation was "running above 11 percent." On Saturday, October 6, 1979, at an evening press conference, he announced a change in method. The Fed would stop targeting the federal funds rate and instead control the growth of bank reserves, and through them the money supply. Volcker said that "by emphasizing the supply of reserves and constraining the growth of the money supply through the reserve mechanism, we think we can get firmer control over the growth in money supply in a shorter period of time."

Interest rates rose steeply. The effective federal funds rate went from 11.43% in September 1979 to a monthly average of 19.10% in June 1981. The economy went through two recessions in quick succession: January to July 1980, and July 1981 to November 1982, according to the NBER. The Fed essay describes the pain: high rates caused liquidity problems for businesses, put mortgages out of reach for home buyers, and drew protests from farmers, car dealers and members of Congress.

It worked on inflation. Annual CPI inflation fell below 5% in September 1982 and was 2.5% by June 1983. The Fed's Great Inflation essay notes that inflation averaged only 3.5% in the later 1980s. The cost was unemployment of 10.8% in November and December 1982, the highest in the monthly series until April 2020.

Did the UK have stagflation in the 1970s?

Yes, and inflation went higher than in the US. ONS figures for the retail prices index (RPI), the main UK price measure at the time, show annual inflation of 16.0% in 1974 and 24.2% in 1975, with a monthly peak of 26.9% in August 1975. A second wave followed at the end of the decade: 18.0% for 1980 as a whole, peaking at 21.9% in May 1980.

Unemployment rose as inflation stayed high. In the ONS series for people aged 16 and over, the annual rate went from 3.7% in 1974 to 5.4% in 1976, then from 6.8% in 1980 to 10.7% in 1982 and 11.8% in 1984. For the modern UK squeeze on prices and incomes, see our page on the cost of living crisis.

What is the difference between stagflation and a recession?

A recession is about falling activity: the NBER defines it as a significant, widespread decline that lasts more than a few months. Prices often rise more slowly in a recession, because demand weakens. Stagflation adds high inflation to weak activity. It can include recessions (the 1970s had three in the US) but it also covers stretches of slow growth between them.

The distinction matters for policy. In an ordinary recession a central bank can cut interest rates. In stagflation, cutting rates risks more inflation and raising them risks more unemployment. Our guides to what a recession is and to recession vs depression cover the other end of the scale.

Was the inflation of 2021-23 stagflation?

Not by the usual definition. US consumer prices rose 9.0% in the year to June 2022 on the seasonally adjusted index, but unemployment was 3.6% that month and fell to 3.4% in April 2023, and the NBER has dated no recession since April 2020. Inflation was high while the job market was strong. The story of that period is on our page about inflation after COVID.

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