What Is Stagflation and Why Does It Matter in 2026?

How Did the Term "Stagflation" Come About?

The word itself is a blend of "stagnation" and "inflation." British politician Iain Macleod first used it during a 1965 speech to the House of Commons. At the time, the United Kingdom was stuck in an uncomfortable spot, as prices were climbing, but the economy was barely moving. Macleod needed a word for something that wasn't supposed to exist, so he made one up.

Before Macleod's speech, the dominant framework in economics was the Phillips Curve. This model, widely accepted from the late 1950s onward, showed a clean tradeoff between inflation and unemployment. When unemployment dropped, inflation went up. When inflation dropped, unemployment went up. Policymakers treated it almost like a dial they could turn with the options being accept a little more inflation to get a little more employment, or vice versa.

Stagflation broke that dial. It showed that unemployment and inflation could rise together, and the Phillips Curve couldn't explain why. This forced an entire generation of economists to rethink their assumptions about how modern economies actually work.

What Actually Causes Stagflation?

Stagflation doesn't come from a single source. It usually takes a combination of bad luck and bad policy happening at the same time.

Supply Shocks

The most common trigger is a sudden disruption to the supply side of the economy. When the cost of producing goods jumps sharply due to an outside factor such as of an oil embargo, a war, or a pandemic, companies face a tough set of choices. They can raise prices to cover their higher costs, or they can cut production and lay off workers. In most cases, they do both. The result is rising prices and rising unemployment happening together.

The 1973 OPEC embargo is the textbook example. Arab oil-producing nations cut off exports to countries that supported Israel during the Yom Kippur War. Oil prices went from about $3 per barrel to nearly $12 in a matter of months. Every business that relied on energy which is essentially every business saw its costs explode.

Policy Mistakes

Supply shocks alone don't always cause stagflation. They need help from poor policy decisions, and those usually come in two flavors.

On the monetary side, central banks sometimes keep interest rates too low for too long. Cheap money encourages borrowing and spending, which pushes prices up. If the central bank waits too long to respond, inflation builds momentum and becomes much harder to stop.

On the fiscal side, governments can overspend in ways that add fuel to the fire. The US Employment Act of 1946, for instance, required the federal government to promote "maximum employment." While the goal was reasonable, it sometimes led policymakers to prioritize job creation even when inflation was already running hot.

The Wage-Price Spiral

Once inflation gets high enough, it starts to feed on itself. Workers see prices rising and demand higher wages to keep up. Businesses then raise prices even more to cover those higher wages. And the cycle repeats.

This is what economists call "de-anchored expectations." When people stop believing that inflation will come back down, they start making decisions such as salary negotiations, price setting, contract terms based on the assumption that inflation will stay high or go higher. At that point, inflation becomes a self-fulfilling prophecy, and it takes a serious policy shock to break the cycle.

People waiting in line at the unemployment office while their expenses are skyrocketing. Source: Cleveland Fed

The Key Figures Who Shaped the Stagflation Story

Several individuals played defining roles in how stagflation was understood, experienced, and ultimately resolved.

Paul Volcker is probably the most important name on this list. When he took over as Federal Reserve Chair in 1979, US inflation was spiraling out of control. His solution was blunt and painful: raise interest rates so high that borrowing became extremely expensive, forcing the economy to slow down. The federal funds rate peaked near 21% in 1981. The result was two back-to-back recessions and significant job losses, but it worked. Inflation dropped from over 13% to below 4% within a few years. Volcker's approach became the blueprint for how central banks handle runaway inflation.

Margaret Thatcher faced a similar crisis in the United Kingdom. Elected in 1979 during the so-called "Winter of Discontent" was a period of widespread strikes and economic paralysis in which she pursued aggressive free-market reforms. She reduced trade union power, cut public spending, and embraced tight monetary policy. Her approach was deeply controversial and caused real hardship in many communities, but it did bring inflation under control.

Milton Friedman and Edmund Phelps deserve credit for seeing the problem before it arrived. Both economists argued in the late 1960s that the Phillips Curve was flawed and that trying to permanently trade higher inflation for lower unemployment would eventually backfire. Their predictions turned out to be remarkably accurate, and their work reshaped macroeconomic theory.

Jerome Powell, the current Federal Reserve Chair, re-entered this conversation in April 2025 when he publicly warned that new tariff policies posed a stagflationary threat. His comments signaled that the Fed was taking the risk seriously and watching incoming data closely.

What Happens When Stagflation Takes Hold

The consequences of stagflation are often described as a "financial vise" because they squeeze households, businesses, and governments from multiple directions at the same time.

For workers and consumers, the most immediate effect is a loss of purchasing power. When prices rise faster than wages, which they almost always do during stagflation, makes it so people can afford less even if their nominal pay stays the same. Essentials like food, housing, and energy take up a bigger share of the household budget, and discretionary spending gets cut. In practical terms, it feels like getting a pay cut without your salary actually changing.

For businesses, the picture is equally difficult. Higher input costs eat into margins, and weaker consumer demand means lower revenue. Many companies respond by freezing hiring, cutting hours, or laying off staff. This pushes unemployment higher, which further reduces consumer spending, and the cycle feeds on itself.

Financial markets tend to suffer as well. Equities typically underperform during stagflationary periods because corporate earnings get squeezed from both sides higher costs and lower sales. Bonds can also struggle if inflation erodes the real value of fixed-income payments. The asset classes that tend to hold up better are those with a natural hedge against inflation, like commodities and real estate.

The Central Bank Dilemma: Why Stagflation Is So Hard to Fix

This is the part that makes stagflation genuinely dangerous from a policy standpoint. The standard tools for fighting inflation and the standard tools for fighting a recession work in opposite directions.

If a central bank raises interest rates to cool inflation, borrowing becomes more expensive. That slows down investment, reduces consumer spending, and can push the economy deeper into recession. Unemployment goes up. In a normal recession without inflation, you'd do the opposite such as cut rates, inject liquidity, and stimulate demand. The dilemma is you can't stimulate demand when prices are already rising too fast, because that just makes inflation worse.

This is exactly the trap that policymakers found themselves in during the 1970s. For most of the decade, the Fed tried to find a middle ground such as raising rates a little, then cutting them when unemployment climbed, then raising them again when inflation spiked. It didn't work as intended. The economy just oscillated between bad and worse until Volcker finally chose to prioritize inflation at all costs, accepting the recession that came with it.

In 2025, the Fed faces a similar dilemma, but with the added complication of much higher debt levels. Raising rates aggressively could trigger a wave of defaults among overleveraged borrowers. Keeping rates low could let inflation expectations become permanently embedded. There's no easy answer.

How Emerging Markets Get Hit the Hardest

While stagflation is painful for advanced economies, it can be devastating for emerging market and developing economies (EMDEs). The 1970s and 1980s demonstrated this clearly.

When the Federal Reserve raised rates dramatically under Volcker, the US dollar strengthened significantly. For countries in Latin America, Sub-Saharan Africa, and parts of Asia that had borrowed heavily in dollars, the math suddenly became catastrophic. Their debts were denominated in a currency that was rapidly appreciating, and the interest payments on those debts were rising at the same time. Many countries including Argentina, Brazil, and Mexico defaulted or required emergency restructuring.

The same dynamic could repeat in 2025. Many EMDEs entered the current period with elevated debt levels and limited fiscal buffers. If global stagflation forces the Fed and other central banks to tighten monetary policy more aggressively, capital flows could shift away from emerging markets, currencies could weaken, and debt servicing costs could spike. The World Bank has flagged this as one of the most serious systemic risks in the current environment.

How to Protect Your Finances During Stagflation

Understanding the macro picture is important, but so is knowing what to do about it at a personal level. Here are the strategies that financial experts consistently recommend during stagflationary periods.

Build a larger cash buffer. The standard advice of keeping three to six months of expenses in an emergency fund still applies, but it needs to be recalculated for an inflationary environment. If your monthly costs are rising 8-10% per year, the number you saved last year is already outdated. Reassess your baseline expenses regularly and adjust your savings target upward.

Diversify into inflation-resistant assets. Not all assets respond to stagflation the same way. The ones that tend to hold value or appreciate include:

• Gold and precious metals - historically one of the strongest hedges against inflation and currency debasement
• Commodities - energy, agriculture, and industrial metals often rise in price during inflationary periods because they are the inputs whose rising cost is driving the inflation
• Real estate - property values and rental income tend to keep pace with inflation over time, though they can be volatile in the short term
• Manage your debt aggressively - This is one of the most overlooked steps. During stagflation, central banks raise interest rates to fight inflation. If you hold variable-rate debt such as credit cards, adjustable-rate mortgages, lines of credit,  your payments will increase automatically. Paying down high-interest variable debt before rates climb further can save you significant money and reduce your financial vulnerability.

What the Stagflation Debate Means for Crypto and Digital Assets

For an audience already active in crypto markets, the stagflation discussion has some specific implications worth thinking about.

Bitcoin and other digital assets have never existed during a true stagflationary episode. The asset class was born in 2009, during the recovery from the Global Financial Crisis, and matured during a decade of low interest rates and abundant liquidity. So there's no historical playbook for how crypto behaves when growth stalls and inflation persists simultaneously.

That said, the narrative around Bitcoin as "digital gold" which is known as a scarce, decentralized store of value could gains traction during periods when trust in traditional monetary policy weakens. If central banks appear unable to manage stagflation effectively, or if fiat currencies lose purchasing power at an accelerating rate, demand for alternative stores of value could increase. This is a thesis, not a guarantee, but it's one that many institutional investors are actively evaluating.

The more immediate risk for crypto markets is the liquidity environment. If central banks tighten aggressively to fight inflation, risk assets across the board including crypto would likely come under pressure. The key variable to watch is whether policymakers prioritize fighting inflation (bearish for risk assets in the short term) or supporting growth (potentially more favorable for speculative assets but with higher long-term inflation risk).

Stagflation Is Back on the Radar and That Should Change How You Think

Stagflation isn't just a chapter in an economics textbook. It's a real and recurring risk that can reshape portfolios, destroy purchasing power, and force painful policy choices. The 1970s showed what happens when policymakers underestimate it. The 2025-2026 landscape with tariff shocks, geopolitical instability, pandemic aftereffects, and record debt levels is showing early signs that rhyme with that era.

The good news is that we've been here before. Central banks, for all their limitations, have learned from the Volcker era. And individual investors who understand the dynamics of stagflation can position themselves ahead of the curve rather than reacting after the damage is done. The playbook isn't complicated: diversify, manage debt, build cash reserves, and pay close attention to what central banks do next. As the old adage says, watch what they do and not just what they say.