What is stagflation?: Why economists are worrying about a 1970s-style catastrophe

Soaring consumer prices, supply chain shocks, rising energy costs and a hawkish Federal Reserve determined to bring inflation under control: These are the worrisome attributes of the U.S. economy that have some experts sounding the alarm over a possible return to 1970s-style “stagflation.”

Stagflation is the combination of economic stagnation and high inflation, characterized by soaring consumer prices as well as high unemployment. 

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The phenomenon ravaged the U.S. economy in the 1970s and early 1980s, as spiking oil prices, rising unemployment and easy monetary policy pushed the consumer price index as high as 14.8% in 1980, forcing Fed policymakers to raise interest rates to nearly 20% that year. 

People shop for groceries at a supermarket in Glendale, California January 12, 2022.  (ROBYN BECK/AFP via Getty Images / AP Newsroom)

A telltale sign, and consequence, of stagflation is rising energy prices, according to many economists, who believe it occurs when a sudden increase in the cost of oil reduces an economy’s productive capacity. For instance, in 1973, the Organization of Petroleum Exporting Countries imposed an embargo on oil supplies to the U.S. over its support for Israel.

The onset of the embargo exacerbated an upward spiral in oil prices, with the price per barrel doubling and then quadrupling. Rising oil costs imposed sky-high costs on consumers, who were forced to confront long lines at gas stations and rationing measures like “odd-even” purchases by license place number.

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It was a major shock for an economy that had become reliant on cheap, foreign oil. 

Although the crisis seemed to fade with the removal of the oil embargo in 1974, the relief was temporary: The Iranian revolution brought on a second wave of dramatically high prices in 1978-1979. 

Some economists believe the U.S. economy is showcasing signs of “stagflation” today, as the Russian invasion of Ukraine sent oil prices soaring. Americans were already grappling with the hottest inflation in 40 years, which has prompted the U.S. central bank to begin aggressively tightening monetary policy with a series of expected interest rate hikes.

Larry Summers, president emeritus of Harvard University, speaks during a discussion on “A Reform Agenda for Europe’s Leaders” during the World Bank/IMF annual meetings in Washington Oct. 9, 2014.  (REUTERS/Joshua Roberts / Reuters Photos)

Former Treasury Secretary Larry Summers, a prominent inflation hawk, has accused the Fed of misinterpreting the inflation spike and waiting too long to take action to quell the price spike. By doing so, Summers wrote in a recent Washington Post op-ed, the central bank has paved the way toward “stagflation.”

“I believe the Fed has not internalized the magnitude of its errors over the past year, is operating with an inappropriate and dangerous framework, and needs to take far stronger action to support price stability than appears likely,” Summers wrote. “The Fed’s current policy trajectory is likely to lead to stagflation, with average unemployment and inflation both averaging over 5 percent over the next few years — and ultimately to a major recession.”

Summers it not alone in his opinion. 

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Danielle DiMartino Booth, the CEO and chief strategist of Quill Intelligence and a former adviser to a Dallas Fed president, said that stagflation “appears to be an imminent development.” She cited dwindling economic growth forecasts for the first quarter as well as inflation for energy and food that is double what it was in the 1970s.

“Rather than having the ability to ease monetary policy into a slowing economy, the Fed is embarking on a tightening campaign,” she said.