Stagflation is one of the most difficult economic conditions to navigate, both for policymakers and investors. Though relatively rare, history provides valuable examples of stagflationary crises that can offer insights into today’s economic risks. The 1970s stagflation in the UK and the US remains the most well-documented case, but other episodes around the world also highlight the dangers of mismanaging inflation and economic growth. By examining these historical examples, investors can better understand the warning signs, policy pitfalls and potential strategies for protecting their portfolios in stagflationary environments.
THE 1970s UK AND US STAGFLATION CRISIS: CAUSES, EFFECTS & POLICY RESPONSES
The most severe and widely studied case of stagflation occurred in the 1970s, when both the United Kingdom and the United States faced an extended period of high inflation, economic stagnation and rising unemployment. This period upended conventional economic thinking and forced central banks and governments to rethink their approach to monetary and fiscal policy.
Several interlinked factors contributed to the stagflationary crisis of the 1970s:
Oil price shocks: One of the biggest catalysts was the 1973 oil crisis, triggered when the Organization of Arab Petroleum Exporting Countries (OAPEC) imposed an oil embargo on nations supporting Israel during the Yom Kippur War. This led to a fourfold increase in oil prices, pushing up the cost of energy and transportation, which in turn drove inflation across the economy. A second oil shock in 1979, following the Iranian Revolution, compounded the problem.
Wage-price spirals: Many Western economies, including the UK and the US, had powerful labour unions that negotiated automatic wage increases tied to inflation. As prices rose, workers demanded higher wages, which further pushed up costs for businesses. This cycle created a self-reinforcing inflationary loop that was difficult to control.
Loose monetary policy in the 1960s: Before the crisis, central banks had maintained expansionary monetary policies to support economic growth. In the US, the Federal Reserve kept interest rates low to stimulate employment, while in the UK the government pursued Keynesian-style demand-side policies that increased government spending. However, when inflation began to rise due to supply-side shocks, these policies worsened the situation.
Declining productivity and global competition: The post-war boom of the 1950s and 1960s had masked structural weaknesses in many Western economies. Productivity growth slowed and increasing competition from emerging economies like Japan reduced the competitiveness of British and American manufacturing industries.
Political and policy mistakes: In the UK, successive governments struggled to contain inflation while maintaining economic stability. The government introduced wage and price controls in an attempt to curb inflation, but these measures failed and led to market distortions. In the US, the Nixon administration’s decision to abandon the gold standard in 1971 contributed to currency instability and further inflationary pressures.
THE IMPACT OF THE 1970s STAGFLATION
The effects of stagflation were widespread and devastating for both economies and financial markets.
Persistent inflation: In the UK, inflation peaked at over 24% in 1975, while in the US, inflation remained above 10% for much of the late 1970s. The rising cost of living eroded household incomes and savings.
Rising unemployment and strikes: As businesses struggled with high costs, layoffs increased. In the UK, the ‘Winter of Discontent’ in 1978-79 saw widespread strikes as workers protested stagnant wages and rising prices.
Stock market turbulence: Equities performed poorly, as high inflation eroded corporate earnings and investor confidence declined. In real terms, stock market returns were negative, forcing investors to rethink traditional investment strategies.
Currency depreciation: The British pound and the US dollar both suffered from devaluation as inflation outpaced interest rate adjustments, leading to a loss of purchasing power.
POLICY RESPONSES TO STAGFLATION
Governments and central banks initially struggled to find an effective response to stagflation. Traditional Keynesian economic policies, which had worked in previous downturns, were largely ineffective.
Monetary policy tightening: By the late 1970s, policymakers recognised that inflation had to be tackled aggressively. In the US, Federal Reserve chairman Paul Volcker dramatically raised interest rates, peaking at 20% in 1981, to break the inflationary cycle. While this move triggered a recession, it ultimately restored price stability.
Shift towards free market policies: In the UK, the election of Margaret Thatcher in 1979 marked a shift towards market-oriented economic policies. Her government reduced the power of trade unions, cut public spending and implemented monetarist policies to control inflation. While these measures were painful in the short term, they helped bring the UK economy back to stability.
Lessons for investors: The 1970s crisis demonstrated that long-term inflation control is essential for stable financial markets. It also highlighted the importance of diversified portfolios and investing in inflation-resistant assets such as commodities and real estate.
OTHER GLOBAL EXAMPLES OF STAGFLATION
While the 1970s crisis remains the most well-known example, other countries have also experienced stagflationary periods that offer useful insights.
Japan in the 1990s – A different form of stagnation: While Japan did not face stagflation in the same way as the UK or US, it experienced prolonged economic stagnation with deflation rather than inflation. The bursting of the asset bubble in 1991 led to a decade of slow growth, high unemployment and ineffective policy responses. The Bank of Japan’s failure to act decisively early on contributed to the country’s ‘Lost Decade’, offering lessons on the dangers of delayed monetary intervention.
Emerging market stagflation – Latin America in the 1980s: Several Latin American countries, including Argentina and Brazil, faced severe stagflationary crises in the 1980s due to excessive government borrowing, external debt crises and runaway inflation. These episodes highlight the risks of fiscal mismanagement and currency instability, particularly for economies reliant on foreign capital.
WHAT INVESTORS LEARNED FROM PAST STAGFLATIONARY EPISODES
Historical stagflationary crises provide crucial lessons for investors today.
- Inflation must be controlled early: Central banks must act decisively to prevent inflation from spiralling out of control. Delayed responses, as seen in the 1970s, make the problem worse and require harsher measures later.
- Energy price shocks can trigger stagflation: The 1970s crisis demonstrated how supply-side shocks, particularly in commodities, can lead to stagflation. Investors should monitor oil prices, energy supply chains and geopolitical risks.
- Traditional safe-haven assets may not work: Bonds, which typically perform well during recessions, struggle in stagflationary environments due to inflation eroding real returns. Investors should consider assets like gold, commodities and inflation-protected securities.
- Equities can struggle, but some sectors benefit: The 1970s showed that consumer discretionary stocks and growth companies tend to underperform, while commodities, energy and defensive stocks can hold up better.
- Policy mistakes can prolong the pain: Governments must balance inflation control with economic growth. Excessive intervention, such as wage and price controls, can distort markets and worsen stagflation.
By studying these historical episodes, investors can better prepare for potential stagflationary risks today. While economic conditions evolve, the fundamental challenges of stagflation remain the same, making historical lessons invaluable for modern investment strategies.
This Trustnet Learn article was written with assistance from artificial intelligence (AI). For more information, please visit our AI Statement.