Inflation and unemployment usually move in opposite directions. When both rise at the same time, economists call it stagflation, and it’s one of the hardest problems to fix. Here’s why.
Stagflation is a blend of two words: stagnation and inflation. It describes an economy where prices are rising quickly, but growth is weak or going backwards and unemployment is rising.
That’s an unusual mix. Normally, high inflation comes with a strong economy, as businesses and households spend heavily. A weak economy usually brings lower inflation, as demand falls.
What causes it
Stagflation is usually caused by a supply shock, a sudden increase in the cost of producing goods and services.
The classic example is a surge in oil prices. When oil becomes much more expensive, the cost of fuel, transport, electricity and many goods rises, pushing up inflation. At the same time, households and businesses have less money left over to spend on other things, which slows the economy.
The 1970s
The most famous period of stagflation was in the 1970s. Oil prices quadrupled after Arab oil producers imposed an embargo in 1973, and surged again after the Iranian revolution in 1979.
Many developed countries, including Australia, suffered high inflation and high unemployment at the same time. In Australia, inflation went above 15% in the mid-1970s.
It ended in the U.S. after Federal Reserve chair Paul Volcker raised interest rates to around 20%, crushing inflation but causing a deep recession in the early 1980s. Australia also went through painful recessions in the early 1980s and early 1990s before inflation was brought under control.
Why it’s so hard to fix
Central banks usually fight inflation by raising interest rates, and fight weak growth by cutting them. Stagflation forces them to choose.
If they raise rates to bring inflation down, they risk making unemployment worse. If they cut rates to support jobs, inflation could become entrenched, as people come to expect prices to keep rising and demand higher wages.
Most modern central banks, including the Reserve Bank of Australia, have concluded that letting inflation stay high is more damaging in the long run, so they generally prioritise bringing it down.
Could it happen again?
Economists warned of stagflation risks after the COVID-19 pandemic and Russia’s invasion of Ukraine pushed up energy and food prices.
In 2026, the disruption to oil supplies through the Strait of Hormuz revived those concerns, pushing up fuel prices around the world while economic growth slowed.
Stagflation isn’t inevitable after an oil shock, though. Economies today use less oil for each dollar of output than in the 1970s, and central banks are more focused on keeping inflation expectations in check.
