Stagflation forced us to rethink how we manage economies. Will it make a comeback?

It’s a horror movie monster encouraging audiences to ponder the same possibility with every reboot: will it win this time? Because in the 1970s, arguably, it won.

Logic seemed to invert. Upward pressure on inflation is normally a symptom of a warming economy and good times to come; but as annual inflation rose in the UK from 6.4% in 1970 to 18% by 1980, in the US from less than 6% to 13.5% during the same period, and in France from about 5% to more than 13%, economies didn’t grow in kind. Quite the opposite.

GDP growth slipped in all three countries between 1970 and 1980, as unemployment hit troubling levels. The world needed a word for such a toxic combination, and it got one.

A British minister debuted the term “stagflation” in the UK's House of Commons on the eve of that painful decade. Usage spread widely soon after that.

Stagflation has occasionally reared its head in the decades since, prompting unsettling reminders. In the wake of the pandemic, mentions in the media cropped up enough to pique broad curiosity; Google searches for the term in Germany surged, as growth there faltered while energy prices rose.

Last year, Australians were wondering if a return to 1970s-style stagflation was imminent as inflation ticked up and GDP languished. In the UK, a recent central bank distress signal for that economy stirred stagflation fears.

In the US, conditions are a far cry from 1970s-level malaise, but there’s been a whiff of dispiriting nostalgia in the air. A few downbeat headline indicators, mixed with a heavy dose of policy uncertainty, have raised alarms. Investors have poured money into a stock trade that actually bets on a future of tariff-induced stagflation.

Yet, at least theoretically, stagflation shouldn’t happen anymore. Not like it has in the past, anyway.

That’s because when it became evident that the ways in which economies had been managed in the early 1970s made them vulnerable, policy-makers sought alternatives. There was a general shift from a Keynesian emphasis on government intervention to guide decision-making, to a more neoliberal reliance on free markets, austerity, and privatization.

There are no absolutes, of course. Keynesian methods resurfaced to help tamp down the effects of the global financial crisis of 2008, for example – a low point that’s been widely blamed on neoliberalism run amok. More recent efforts to direct heavy government spending at critical industries have been labelled “post-neoliberal.”

That renewed taste for government intervention in an economy, in combination with shifting political dynamics and heightened geopolitical tension, make inflation more difficult to predict, said Gregory Daco, the chief economist at EY. “Stagflation isn’t just a relic of the past,” Daco said, “it’s an ever-present risk.”

Geopolitical tension was one of the primary reasons stagflation was able to wreak havoc a half-century ago. A war in the Middle East early in the 1970s led to an oil embargo, which sent global energy prices surging and quickly made getting from place to place or heating a home far more difficult in many countries. Drivers in the US found themselves waiting in lines eight kilometers long to refuel.

Later in the decade, a revolution in Iran more than doubled the price of oil. People suffered from similar fallout. Stagflation creates a troubling dilemma, Daco said: intervene aggressively against inflation, and you risk stifling growth and spurring unemployment. Governments opted to play it safe, and in many ways stagflation became a way of life.

To undo the damage, a lot of bitter medicine was eventually dispensed.

Central bankers in the US intervened with a vengeance in the early 1980s, cranking up interest rates and pushing that country into a recession – but also cooling inflation. Unemployment also trended downward, as clarity on official intentions grew and the economy regained strength.

In the UK, interest rates were also raised as public spending sharply declined – elements of a clear break from prior policy and a relentless focus on inflation that eventually resulted in broad gains, albeit not without consequences. Around the same time, France restructured by making a distinct turn towards austerity that curbed its own public spending.

In all of these cases, winning confidence played a big role in recovery. That required consistency; people had to believe decision-makers would follow through on a coherent agenda, whether people were fans of that particular agenda or not.

"A key risk is that uncertainty itself can fuel inflationary pressures,” Daco said, as people hoard and businesses embrace the “sweet taste” of pricing power.

Some experts are now warning that heightened uncertainty about protectionist policy plans in particular, coupled with geopolitical conflict not unlike what erupted in the early 1970s, is increasing the risk of serious stagflation.

Ultimately, the big economic lesson learned from the 1970s might not have as much to do with Keynesian theory versus neoliberalism, as it does with making an economy simply serve the greatest number of people possible by going with what works – instead of clinging to an idea about how it should work.