The next big risk to the U.S. economy may be summed up in one word.
And no, it’s not necessarily recession, though economists are evenly split on the risks one are coming.
Instead, 80% of economists in the same survey named stagflation as the greater long-term risk to the economy, according to the Securities Industry and Financial Markets Association. The next biggest risk they identified was deflation, with 13% of respondents.
Moreover, a recent Bank of America global fund manager survey found fears of stagflation are the highest they have been since June 2008. Stagflation is “by far and away the most popular description of what the economic backdrop will be in the next 12 months,” according to the report.
What is stagflation?
Stagflation is a term coined in the 1970s when there was simultaneous high inflation and economic stagnation or high unemployment, according to Jonathan Wright, professor of economics at Johns Hopkins University.
While there were some nasty recessions back then, many economists aren’t expecting a return to anything like that now, he said.
“The sense in which you had stagflation in the 1970s is not one that I think is at all in the cards,” Wright said.
However, high inflation is prompting the Federal Reserve to raise interest rates — known as tightening monetary policy. With that, it is “quite likely” the unemployment rate will rise “a fair bit” from the 3.6% it is at now, Wright said.
The result may at least be a mild recession, he said.
Stagflation may happen if a recession sets in before inflation has gone down to where the Fed wants it to be, Wright said. For example, if unemployment were to go up to about 5% and Consumer Price Index inflation were also at above 5% in 2023, that would be a kind of stagflation, though not to the degree we experienced in the 1970s, he said.
“It certainly would mean that the job market would be a lot less hot than it’s been,” Wright said.
In the near term, the labor market may cool simply by having fewer vacancies, he said.
How likely is stagflation?
Despite surveys sounding the alarm on stagflation, not everyone agrees it’s inevitable.
“It doesn’t seem like a high probability,” said Josh Bivens, director of research at the Economic Policy Institute.
To have stagflation, you need both high unemployment and high inflation at the same time, which Bivens does not see as likely.
“If we had a situation where unemployment rose pretty sharply, I actually think that would likely cause inflation to start coming down pretty sharply,” Bivens said.
A more likely scenario is that if we end the year with a series of interest rate hikes by the Federal Reserve, we could be in a recession by 2023, he said.
“If that happens, I just expect inflation to relent pretty quickly,” Bivens said.
How can you prepare for a recession or stagflation?
A combination of inflation and shrinkflation, where product companies reduce the contents of everything that we buy, is making it so people’s money just doesn’t go as far now, said Ted Jenkin, a certified financial planner and CEO of oXYGen Financial in Atlanta.
Now, stagflation is also a possibility that clients are asking about, Jenkin said.
“I think it’s inevitable that we’re going to hit a recession,” Jenkin said. “Whether this is a mild recession or we go into stagflation will be the big question.”
Consequently, now is a great time to revisit your personal financial plan.
“This is the absolute time for people to batten down the hatches and beef up the foundation of their financial house,” Jenkin said.
Try to aim for at least six months’ worth of emergency expenses in case a downturn does happen, he said. Also make sure you have prepared a recent budget to see if there are places where you can cut back.
Additionally, take a look at any adjustable rate debt you may have — credit cards, mortgages, student loans — and see if you can pare those balances down or refinance them. Now that interest rates are poised to go up, those balances will become more expensive.
Moreover, it’s a great time to invest in yourself to be more marketable professionally if layoffs become the norm.
“Make sure you’ve really brushed up on your skills and competencies or education so that if you the job market gets tighter, you’re marketable,” Jenkin said.