Stagflation or Recession: With Tariffs on Pause, Is the Economy Really OK?

Even if you haven’t lived through a major recession, it’s scary to think about. Even more frightening is stagflation, a combination of “stagnation” and “inflation.” 

Last month, President Trump’s turbulent tariff agenda resurrected fears of stagflation, a rare scenario in which prices increase while the economy slows and the labor market gets battered. 

Since February, new import taxes have been announced, delayed, raised and reduced in quick succession. After Trump’s temporary truce with China this week, the risk of a severe economic crisis has fallen considerably. Markets are cautiously optimistic — for now. 

Yet experts still warn that a trade war could drive up prices, curtail consumer spending and propel an economic downturn. The toxic combination conjures up the major economic crisis in the 1970s, marked by double-digit inflation, steep interest rates and soaring joblessness.

If a recession or stagflation materializes, it would be a “self-inflicted” injury resulting directly from US government policy, said Kathryn Anne Edwards, labor economist and independent policy consultant. 

On May 7, Federal Reserve Chair Jerome Powell seemed to confirm the risk. “If the large increases in tariffs that have been announced are sustained, they’re likely to generate a rise in inflation, a slowdown in economic growth and a rise in unemployment,” Powell said. Those impacts could be short-lived or more long-term, he added.

Stagflation certainly isn’t a foregone conclusion. But it would be a worse economic prognosis than a recession, a long-lasting shock to the system, especially as the government lacks effective policy prescriptions to control it. “There may not be an easy path to monetary or fiscal stabilization,” said James Galbraith, economics professor at the Lyndon B. Johnson School of Public Affairs at the University of Texas at Austin. 

Financial markets have been volatile. US households, already coping with the high cost of living, are preparing for what’s next. Whether we’re headed for a recession or a period of stagflation, taking steps to proactively safeguard your finances becomes all the more critical. 

Are we in a recession?

Economic uncertainty and instability, like we see today, often trigger recessionary conditions, as companies and households start pulling back on spending and investment. 

Despite declining consumer sentiment and a weakening job market, the central bank says “the economy is still in a solid position.” Since Trump began rolling back some of his most aggressive trade measures, markets have been forecasting a lower risk of a downturn. 

However, some economists say a recession is inevitable. The economy regularly experiences periods of booms and busts, with downturns typically occurring once every five to seven years.

“We are due for a reset and a slowdown in the economy,” said Greg Sher, managing director at NFM Lending. Sher also believes that unemployment is worse than what the headline figures report.  

During a recession, joblessness goes up, and the prices of goods begin to drop. It’s generally harder to obtain financing, as banks tighten their requirements to minimize their risk of lending to borrowers who may default on loans. 

Certain macroeconomic hallmarks, like shrinking GDP and rising unemployment, are consistent across all recessions. But every US recession is unique, with a different historical trigger. The Great Recession of 2007-2009, which kicked off with the subprime mortgage crisis and the collapse of financial institutions, was the longest. The COVID-19 pandemic recession, resulting from lockdowns and the loss of 24 million jobs, was the shortest recession on record.

Working-class and middle-class households generally experience the day-to-day hardship of a recession well before the National Bureau of Economic Research officially calls it. Folks on the margins also experience a much slower recovery after a recession is declared to be over. 

Relying on hard data like GDP and employment to determine recessions is faulty. Because those figures are backward-looking, they tell us where the economy was before, not necessarily where it’s heading. 

That said, here are some of the key warning signs economists look out for in a recession: 

What is stagflation?

Stagflation would mean having less purchasing power, as prices go up and saving becomes more difficult. Jobs become harder to find, your investments might take hits and interest rates could rise. 

Stagflation is typically measured by the “misery index,” the sum of the unemployment rate and the inflation rate, reflecting the level of economic distress felt by the average person.

For decades, experts didn’t believe stagflation was possible because it goes against basic principles of supply and demand. Usually, when more people are out of work, prices go down because demand for goods and services is lower. 

But stagflation reared its head in the 1970s. Growing government debt, fueled by military spending on the Vietnam War, sent prices soaring. Soon after, the energy crisis hit. In 1973, OPEC’s oil embargo resulted in a massive supply shock, worsening inflation and depressing output. 

Official unemployment peaked at 9% while inflation kept ratcheting higher and eventually surpassed 14% year over year. A second oil supply shock in 1979 prompted the Federal Reserve to raise interest rates to record highs, above 20%. While that approach worked to bring inflation down, it prompted a severe recession. 

While recessions are cyclical, stagflation is a rare and complex phenomenon caused by a major supply shock to essential items like oil or food. When supplies are limited, prices go up at an abnormal rate, which hurts businesses, household finances and economic growth. 

Are we headed for stagflation?

Most economists say the likelihood of entering a period of stagflation is still quite low, but some warn that Trump’s trade policies could fuel the fire. 

According to Sher, there’s a misguided assumption that consumers will be willing to pay the higher cost of goods brought on by tariffs. “Consumers will be more likely to sit on their hands and stop spending, which will further stoke the recession flames,” said Sher. 

Tariffs, or import taxes on goods from another country that are paid by the importer, can have a similar effect to oil supply shocks, causing widespread disruptions and cost increases along supply chains. Companies either pass on those increases to domestic customers, triggering more inflation, or they cut back on investments and output, leading to layoffs and weakened growth. 

Right now, there are some signs of tariff-related inflation, but the full impact on consumer prices likely won’t be seen for several months. Official inflation sits at 2.3%, the slowest annual pace in years. 

Meanwhile, the official US unemployment rate remains relatively low, currently at 4.2%, according to the Bureau of Labor Statistics. Although weaker-than-expected economic data has rattled investors, the dollar and the balance sheets of major financial institutions are strong, unlike in the 1970s. 

“While prices are on the firm side and growth has cooled from a too-warm pace, unemployment remains closer to historic lows than not,” said Keith Gumbinger, vice president at housing market news site HSH.com. “We don’t have stagflation per se, at least as yet.” 

Why stagflation is worse than a recession

At the same time, today’s economy is dangerously fragile, with huge government debt and few tools available to fix problems. “Big tariffs right now wouldn’t just make inflation worse — they could set off a chain reaction of economic trouble that central banks and governments aren’t ready to handle,” said Sher. 

Recessions have an established, if imperfect, playbook to diminish their impact. The Fed, which is in charge of maintaining price stability and maximizing employment, usually lowers interest rates to stimulate the economy and buoy employment during a downturn.

When inflation is high, however, the Fed typically raises interest rates to combat price growth and slow down the economy by making credit and borrowing more expensive for consumers and businesses. The two approaches can’t be taken simultaneously. 

Gumbinger said stagflation is more intractable than a recession. It has a trickier path because the go-to policies used to address one problem often worsen the other. 

Right now, the Fed is in a bind. Lower interest rates can boost a weaker economy, but they can also stoke inflation. If inflation remains sticky, the central bank is more likely to continue pausing rate cuts. 

That kind of government paralysis could drag out economic hardship, especially for the most financially and socially vulnerable populations. While the average recession lasts about 11 months, the last bout of stagflation in the US lasted more than 10 years.

How can you prepare for a recession or stagflation? 

Stagflation could feel like a recession with the added pain of high prices, making it difficult to prepare for and even harder to navigate. Still, experts say you’ll want to take some of the same steps you would ahead of an economic downturn. 

Establish your emergency fund. Having an emergency fund is a good idea in any economy. During an economic downturn, high unemployment can make it harder to get back on solid financial footing if you have a sudden expense. If your savings cover at least three to six months of living expenses, you can more easily weather a financial storm without relying on credit cards or retirement savings.  

Make a financial plan. Focus on paying down debt, particularly high interest credit card debt, so you don’t have to carry a balance when times are tougher. Postpone making any major purchases that overstretch your budget and that you’ll regret having to pay off in a year or two. Avoid panic buying things like laptops, phones or cars just to get ahead of expected price increases. 

Review your investments. Given the level of economic uncertainty, expect the stock market to have more volatility. If you mostly have high-risk investments, consider diversifying with a variety of low-risk accounts, or combining stocks and bonds. Consult with an adviser about inflation-resistant assets and having a more balanced portfolio based on your individual risk tolerance, age and financial goals. 

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