What is stagflation? Has the US seen it before? Here's what you need to know

Think things can't get worse? Now the World Bank has downgraded its forecast for the global economy, citing factors including stagflation – a combination of slow growth and inflation.

The organization on Tuesday predicted that the world’s economy would expand 2.9% this year, down from its forecast of 4.1% in January. And the World Bank’s predictions for 2023 and 2024 aren’t drastically higher, with an estimated 3% growth for both years.  

The World Bank is worried about the impact of Russia’s ongoing invasion of Ukraine, possible food shortages and potential “stagflation.” The war in Ukraine continues to disrupt global trade – including in energy sectors – and commodity prices have spiked and hit countries around the world.  

But what causes stagflation? Has the United States seen stagflation before? Here’s what you need to know:   

What is stagflation and what causes it?

Stagflation happens when economic growth is sluggish while inflation is high. The term lacks a formal definition or specific threshold, but elements include high unemployment and a weakened economy as prices climb.  

One factor that can help cause stagflation is a spike in the cost of raw materials, causing inflation and leaving people with less money to spend.

  • In the 1970s, Saudi Arabia and other countries imposed an oil embargo on the United States and other nations.
  • Oil prices increased as the cost of living grew. In every year from 1974 to 1982, inflation and unemployment in the U.S. were both above 5%.  

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What is the difference between stagflation and inflation?  

To understand stagflation, you have to understand inflation.  

Why is stagflation a serious problem?  

Typically, when the economy is weak, inflation is low because there's less consumer demand and plenty of unused products and services. High inflation is more likely when the economy is strong and  surging consumer demand is driving up prices.

Stagflation offers a worst-of-all-possible worlds scenario of weak growth and sharply rising prices. That poses a dilemma for the Federal Reserve: It can raise interest rates to fight inflation, but that will further hobble a feeble economy.

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Does stagflation lead to a recession?

There isn’t necessarily one step to resolve stagflation, but the World Bank noted that the period of stagflation in the 1970s required interest rate hikes that were so steep they caused a period of recession around the world and led to financial crises in several poor countries.  

Federal Reserve chair Jerome Powell has emphasized that the Federal Reserve would continue raising interest rates until inflation falls steadily, an effort that could risk a recession in the U.S.  

“What we need to see is inflation coming down in a clear and convincing way,” Powell said during a Wall Street Journal conference last month. “And we’re going to keep pushing until we see that.” 

Contributing: Associated Press, Paul Davidson, Nathan Bomey