How Stagflation Works and What to Do About It

Editor's Note: This story originally appeared on NewRetirement.

First, before reading this article, know that there are solutions to every economic problem — at both the personal and macro economic level.

So, even though there is renewed talk of the U.S. economy hitting stagflation, it doesn’t mean that you’ll never be able to retire or run out of money if you do.

But, being forewarned is being fair armed. And, there have been murmurings that stagflation is a possible problem even though Federal Reserve Chair Jerome Powell recently remarked that there was no sign of stagflation in the economy.

What is stagflation? How could it impact your future financial security? Let’s find out.

What Is Stagflation?

Stagflation is a combination of two pretty terrible economic concepts: stagnation and inflation. Okay, but what do those terms mean exactly?

Stagnation

Stagnation is when economic growth — an increase in the output of goods and services — slows. And, this trend can trigger high unemployment.

In the most recent report on gross domestic product, the Bureau of Economic Analysis reported that inflation-adjusted gross domestic product grew slower than had been predicted.

And, while unemployment remains historically low, the job market appears to be softening.

Inflation

Inflation is when the prices for goods and services rise.

Inflation is coming down from the highs in recent years, but the increase in prices is holding steadier than people had hoped.

Stagflation

So, stagflation is a phenomenon where there is little or no economic growth as well as high unemployment at a time when prices are high. This combination of factors can cause rather severe economic hardship for households.

The term first came to use in the 1970s. Most economists say that we are not at risk for stagflation at this time.

Stagflation Is Unlikely

At a recent press conference following the Federal Open Market meeting, Powell was asked to comment on the risk of stagflation. “I was around for stagflation, so I don’t see the ‘stag’ or the ‘flation,'” Powell, 71, responded.

Unemployment numbers are rising, but they remain low. Inflation is sticky, but appears to be falling.

And, even if all the numbers move in the wrong direction, there is still time to maneuver our way around stagflation.

Why Is Stagflation Scary?

Stagflation can be scary because it is hard to fix. Traditionally, the job of fixing inflation (and stagnation) has largely been the responsibility of the Federal Reserve.

However, the tools that the Fed can use to fix inflation (raising interest rates to slow demand) can exacerbate stagnation. And, the ways to fix stagnation (lower interest rates to help businesses grow) can make wages rise and worsen inflation.

Consumer and business sentiment, interest rates, investments, the job market, borrowing, consumer demand, spending, and what things cost are some of the factors swirling in the vortex of stagflation.

“The only known remedy for stagflation is a recession,” said David Wilcox, a senior economist at the Peterson Institute for International Economics and Bloomberg Economics. (Um, that’s not good. A recession is when the economy contracts.)

Stagflation Can Be a Self-Fulfilling Prophecy

The real long-term problem with stagflation is that as households and businesses struggle and worry about the future, they reduce spending and investment.

This economic contraction only serves to perpetuate stagflation.

What to Do if You Are Worried About Stagflation

Just as it is difficult for regulators to manage stagflation, it is also difficult for individual households.

The key may be to focus on flexibility in all aspects of your finances: income, investing, spending and attitude.

Keep Your Emotions in Check

The economy and your approach to your money is not always an art. It is not always a science. In many ways it is most often an emotion.

Emotions like confidence and attitudes like optimism have a huge impact on how the economy performs.

If you feel good about your economic prospects, you are probably spending more money and making investments. If you are worried, you tighten the purse strings.

It is important to be prudent. Look for the good and for opportunities.

Be Flexible With Your Savings and Investments

It is probably best to assess your asset allocation and make sure you have a diverse portfolio to prepare for stagflation or whatever economic twists and turns our future brings.

Some people recommend that you have extra cash on hand for stagflation. Others suggest value investments (stock in companies with strong underlying fundamentals). Investments in things with real values like commodities and real estate is another approach.

Income producing investments may also be a good option. I Bonds have proven particularly popular. Bond ladders and fixed annuities (with inflation protection) can also guarantee returns.

Finally, some experts suggest you look at a barbell approach where you focus on both very safe and relatively risky investments, avoiding middle of the road options.

Be Flexible With Your Spending

Cutting costs is a common response to inflation, stagnation, job loss, and stagflation. However, as explained before, cutting costs can perpetuate stagflation.

Adopting a flexible approach to your spending, cutting discretionary costs when necessary and spending when possible is probably the best approach. Stay on top of your budget. Monitor your costs and adjust as required.

Look for More Flexible Income Sources

Whether you are already retired or still working, preparing for stagflation may involve looking for ways to diversify your income streams.

Passive income streams may prove particularly useful. Seeking gig or part-time work is another approach. Working longer, delaying retirement for a bit may be a pragmatic solution.