What is Stagflation and What Does it Mean for Real Estate?
In the aftermath of the pandemic, the United States, and much of the world, has experienced elevated inflation. CPI inflation has reached an annual rate as high as 9% in this cycle, and while we are now closer to 3%, this still requires restrictive monetary policy. Despite elevated interest rates for almost three years now, the economy has remained strong and unemployment relatively low. This has come into question recently as household debt is spiking, layoffs mount, and the stock market gives back much of its recent gains. With economic uncertainty over tariffs and other policies and consumer confidence fading, a recession in 2025 seems possible. Could stagflation also be a concern?
What is Stagflation and What Causes it?
Stagflation is a combination of the words “stagnation” and “inflation” and was once thought by economists to be impossible. Policies designed to encourage economic expansion and reduce unemployment could lead to inflation and policies designed to cool inflation might slow economic growth and cause greater unemployment. This assumption was proven to be incorrect in the 1970’s as an oil embargo increased the cost of energy and other prices by limiting supply, but also slowed growth. This is not the only potential cause of stagflation, but there is validity to the theory that supply shocks for essential commodities can contribute to it.
As we saw during the pandemic, supply chain disruptions created a shortage of goods and services, as decreased productivity created a risk of a deep recession. Within months, massive stimulus and rate cuts to near zero percent resulted in growth, while pent-up demand from supply shortages led to high inflation. Wages then increased as a result of tighter employment conditions and higher prices, and a wage-price spiral still exists. Now, tariffs and retaliatory measures from other countries threaten to disrupt the supply chain. This is already causing economic uncertainty, leading to job losses and a stock market sell-off, and threatens to increase prices of goods at a time when additional economic stimulus or rate cuts could undo some of the progress made on inflation. While we have not officially fallen into stagflation because GDP growth and employment have remained at acceptable levels, uncertainty over the tariffs’ scope and length is causing immediate economic disruption. Widespread and prolonged use of this protectionist policy could easily take us from a normal late cycle slowdown into a recession or near recession, while adding to existing inflationary pressures.
How do we Stop Stagflation from Occurring?
Stagflation, being the combination of two events, means that we only need to avoid one in order to stop this phenomenon. That doesn’t mean we can stop both. Raising interest rates and slowing government spending might reduce inflation, but is likely to cause a recession and higher unemployment. Reducing taxes or interest rates could spur growth, but would be inflationary and increase the deficit, and might actually cause long term treasury yields to go up, creating higher interest rates for longer. Avoiding inflationary and output-reducing shortages in the market, potentially caused by tariffs and previously caused by an oil embargo, reduces the chances of stagflation and puts us back on track for a soft landing.
What Does Stagflation Mean for the Real Estate Market?
The real estate market has been experiencing a decline in the number of transactions for several years, although this has not tripped up the economy in general. There is minimal distress in the housing market and values have been largely stable, although this is mainly due to the lack of supply, which has mirrored the decrease in demand due to affordability issues. Home values did nearly triple in the stagflation era 1970’s, although they began the decade at such a low starting point, a similar uptrend probably would not occur today.
While current circumstances are different, a repeat of the 1970’s would not be a good thing for the consumer or for real estate in the short-term. A significant economic slowdown or recession would be detrimental to property values since it would increase supply and reduce demand even further, as job losses mount and consumer confidence declines. While that happens, rents could continue to increase as fewer people opt to buy homes, and instead continue to rent. At the same time, development slows due to decreased confidence and increased building costs, resulting from tariffs on imported lumber, gypsum, as well as labor costs. A recession could, however, result in bond buying as a flight to safety, driving treasury yields lower, reducing interest rates, and along with reduced prices, be stimulative for the real estate market. This would also have the added benefit of allowing the federal government to refinance trillions of dollars’ worth of expiring debt at lower than current rates.
Stagflation greatly harms consumers who suffer from both higher prices and lower earnings, a double whammy, which is difficult to fight through economic stimulus or tighter monetary policy. Times of stagflation have been rated based on a scale called the Misery Index, which combines CPI inflation and the unemployment rate. The bitter combination of stagnation and inflation might not be inevitable, but the conditions currently exist to make it a reality.