Stagflation is the economist's nightmare — inflation and stagnation at the same time, with no good options. Raise rates to fight inflation and you risk recession. Cut rates to boost growth and inflation gets worse. Here's why central banks are caught in an impossible position.
Originally published May 25, 2022 · Updated May 2026
We wrote this article in May 2022, when inflation was surging, central banks were scrambling to raise rates, and economists were starting to whisper a word that hadn’t been relevant since the 1970s: stagflation.
Back then, the warning felt urgent but hypothetical. Central banks acted aggressively. Inflation came down. A recession was largely avoided. Most people assumed the danger had passed.
It hasn’t. In 2026, stagflation is back on the agenda — this time driven not by an energy shock or a pandemic, but by something more deliberate and harder to reverse: a sweeping tariff regime that is simultaneously pushing prices up and pulling growth down. Ray Dalio has warned that the US is already in stagflation. Apollo Global’s chief economist says the Fed is quietly preparing for it. The IMF has flagged it explicitly.
The dilemma we described in 2022 is back, and in some ways it’s more complicated than before.
So, What Is the Problem With Stagflation?
Stagflation is one of the most unpleasant conditions an economy can find itself in. As the name implies, it combines stagnant economic growth with high inflation — and typically a rising unemployment rate on top. It’s the economist’s version of being stuck between a rock and a hard place.
In normal conditions, central banks have relatively clear tools. When growth is strong and inflation is rising, they raise interest rates — making borrowing more expensive, cooling spending, and bringing prices down. When growth is weak and unemployment is rising, they cut rates — stimulating borrowing, investment, and economic activity.
Stagflation breaks this logic entirely. Raise rates to fight inflation, and you risk deepening the recession and pushing unemployment higher. Cut rates to stimulate growth, and you risk inflation running further out of control. There is no clean answer. Every response has a painful trade-off.
The 1970s — the last serious stagflationary episode in the Western world — ended only after Fed Chair Paul Volcker raised interest rates to nearly 20%, deliberately inducing a severe recession to break inflation’s back. It worked, eventually. But it caused enormous economic pain first.
What Happened in 2022–2024: The Dilemma, Round One
When we first published this article in 2022, the world had just emerged from the pandemic with supply chains shattered, energy prices spiking after Russia’s invasion of Ukraine, and central banks that had kept rates near zero for years suddenly facing inflation they hadn’t seen in four decades.
The Federal Reserve raised rates from near zero to over 5% between 2022 and 2023 — one of the most aggressive tightening cycles in modern history. The European Central Bank followed. The Bank of England raised rates to their highest level in 15 years. Almost every major central bank in the world was doing the same thing at the same time.
The fear was that this aggressive tightening would tip economies into recession — stagflation’s worst-case outcome. It mostly didn’t. Inflation came down significantly across most Western economies through 2023 and 2024. The labour market proved more resilient than expected. The US achieved something close to a soft landing — inflation falling without unemployment spiking. The Fed began cutting rates in late 2024.
It looked, briefly, like the danger had passed.
The Return of the Dilemma: Tariffs, 2025
Then came the tariffs.
In 2025, the Trump administration implemented the most sweeping tariff regime in modern American history, raising the effective tariff rate implied from customs duties from around 2% to an estimated 11.7% as of January 2026. The stated goals were to protect American manufacturing, reduce trade deficits, and bring supply chains back to US soil.
Whatever the political merits of that argument, the economic effect was immediate and predictable to anyone who had read a macroeconomics textbook. Tariffs are, at their core, a tax on imports. They raise the prices of goods. They disrupt supply chains. And when trading partners retaliate — as China, the EU, and others quickly did — they reduce global trade volumes, which reduces growth.
The result is exactly the combination the 2022 version of this article was warning about: rising prices and slowing growth arriving simultaneously. The IMF stated explicitly that the US was showing the hallmarks of a negative supply shock — weaker growth and higher inflation than projected. Allianz Global Investors warned of an increased likelihood of at least a temporary phase of stagflation, where lower activity and rising price pressures stymie economic growth.
Apollo Global Management’s chief economist Torsten Slok noted that FOMC participants broadly perceive greater upside risks for both inflation and unemployment — an unusual and concerning combination — suggesting the Fed is wary of entering a period where price pressures fail to ease even as labour market conditions weaken.
Stanford’s economic policy research institute put it plainly: the stagflation risk is real, and the inherent ambiguity in the monetary-policy path out of stagflation makes the Fed’s job extraordinarily difficult.
Choose Your Poison — Again
The Fed now finds itself in almost exactly the position we described in 2022, but with an added complication: it has already been through one tightening cycle. Rates have come down from their peak. Cutting further to support growth risks reigniting inflation. Holding or raising rates to contain tariff-driven price pressures risks tipping a slowing economy into recession.
Fed Chair Jerome Powell has acknowledged there is “no risk-free path for policy.” That is a polite way of saying what every central banker privately knows: in stagflation, all the options are bad. The question is which poison you choose.
There is one potential escape route that wasn’t available in the 1970s. If the tariff shock proves temporary — if trade deals are negotiated, tariffs are reduced, and supply chains adjust — then the inflationary pressure could fade without requiring aggressive rate rises. The Trump administration has a history of announcing sweeping tariffs and then walking them back after extracting concessions. If that pattern repeats, the stagflation episode could be shorter and milder than the data currently implies.
But if tariffs persist at current levels, and if trading partners continue retaliating, the Fed faces a genuine and prolonged dilemma with no clean resolution.
What Does This Mean for You?
Stagflation is bad for almost every asset class simultaneously, which is what makes it particularly unpleasant for investors.
Bonds suffer when inflation rises, because fixed payments are worth less in real terms. Equities suffer when growth slows and earnings disappoint. Cash loses purchasing power. The traditional 60/40 portfolio — 60% stocks, 40% bonds — was designed for a world where inflation and growth move in opposite directions. In stagflation, they move in the same direction, and the diversification breaks down.
The assets that have historically held up best in stagflationary environments are: commodities (particularly energy and precious metals), real estate, inflation-protected bonds (TIPS in the US), and certain international equities in countries less exposed to the trade war. Gold specifically tends to perform well when real interest rates are low or negative and uncertainty is high — both of which describe the current environment.
None of this is investment advice. But understanding the macro environment is the starting point for any sensible investment decision.
The Bigger Picture
What the stagflation story of the 2020s illustrates — both the 2022 episode and the current one — is that the post-2008 assumption of permanently low inflation and unlimited central bank flexibility was always more fragile than it looked.
For a decade after the 2008 financial crisis, central banks cut rates to near zero, printed money on an enormous scale, and inflation barely moved. That led many economists and policymakers to conclude that the old rules had changed — that inflation was dead, that central banks had unlimited room to stimulate, that the trade-offs of monetary policy had been permanently softened.
The 2022 inflation surge shattered that assumption once. The tariff-driven stagflation risk of 2025–2026 is shattering it again. Central banks are not all-powerful. Inflation is not dead. Supply shocks — whether from pandemics, wars, or trade policy — can create economic conditions where the standard toolkit simply doesn’t work cleanly.
The dilemma is real. It was real in 2022 and it is real again now. And the central bankers navigating it deserve neither the vilification they receive when they get it wrong, nor the credit they receive when they get it right. They are, in the end, choosing between imperfect options in a world that doesn’t always offer a good one.
This article is for informational purposes only and does not constitute financial advice.