There’s been a lot of talk lately about stagflation, the economic phenomenon putting economic policymakers and central bankers in a tough spot. But what does it all mean for credit unions? And how will the Federal Reserve’s response impact credit unions’ ability to manage their balance sheets and income statements?
What’s Going On?
Q: What Is Stagflation?
A: When the economy slows while prices and unemployment increase.
The Federal Reserve operates under the dual mandate to maintain steady, low unemployment while hitting the desired inflation target. Walking this monetary policy tightrope requires the Fed to keep in check the trade-off between unemployment and inflation. When the economy runs hot, businesses increase hiring and unemployment drops. This tends to correlate with higher inflation. Conversely, when the economy runs cool, economic activity is low, businesses pull back from hiring, and unemployment increases. These periods of low demand tend to correlate with low inflation.
But what happens when the economy is cool yet unemployment and inflation are high? That presents a thorny issue for the Federal Reserve.
Should the Fed lower interest rates to increase business activity and pull Americans back into the workforce? That sounds great, but doing so risks pushing inflation higher than it already is.
Should the Fed raise interest rates to combat high inflation? That risks making unemployment even worse.
This dynamic — known as stagflation — is often triggered when an external shock, including supply chain shortages, war, or, in the current case, tariffs, hits an economy already showing signs of trouble.
A Short History Of Stagflation In America
The most notorious example of stagflation in America is the 1979 oil embargo, when OPEC denied the United States access to oil markets in response to the country’s foreign policy in the Middle East.
Oil prices shot up; inflation increased under debt-related, domestically driven pressures; and the United States entered into a period of stagflation. In the early 1980s, then-Fed chair Paul Volcker made the controversial decision to increase interest rates to tamp down inflation, even at the expense of the rest of the economy, which soon entered into a recession.
FEDERAL FUNDS EFFECTIVE RATE
FOR THE UNITED STATES
SOURCE: Board of Governors of the Federal Reserve System
Tariffs, with their downward impact on economic activity and upward effect on prices, is a policy decision tailor-made to set-off stagflation, being the straw that breaks the camels back on an American economy already showing signs of cracking. Many of today’s business leaders and economists have issued warning calls. Jamie Dimon, CEO of JPMorgan Chase, has said for the United States. And after the May meeting of the Federal Open Market Committee, current Fed chair Jerome Powell acknowledged the role tariffs could play in .
Many in the market are clearly concerned, but what does all of this mean for credit unions?
Stagflation And The Ramifications For Credit Unions
In Washington, DC, how policymakers choose to confront stagflation will have corollary effects on credit union balance sheets across the country. Credit unions are well advised to monitor the following factors.
Member Impact
If the Federal Reserve lowers interest rates to offset the economic impact of tariffs, inflation could increase further, stretching budgets ever thinner. Credit union members, who already tend to make less money than banking customers, have had to further tighten their wallets in the past few years of high inflation.
On the other hand, if the Federal Reserve raises rates to combat inflation, it might hurt the economy, particularly at the margins, putting member employment on shakier ground and compounding lending issues. Think housing affordability is a difficult subject now? Wait until interest rates are double digits.
Investment Portfolios
Casting a large cloud over the Federal Reserve’s policy is the bond market, which is shaky after doubts about the U.S. government’s fiscal situation and weary of any future changes in monetary policy. For credit unions, who keep a large quantity of U.S. treasuries on their balance sheet for investment purposes, the value of those securities could change considerably.
An increase in the interest rate from the Federal Reserve would lower the value of current holdings. As of March 31, 2025, credit unions hold an accumulated unrealized loss on available for sale securities of $23.9 billion. Compare this to when interest rates were near zero in early 2022 and it becomes apparent that a bump in interest rates might have serious consequences for credit union portfolios.
On the other hand, cutting interest rates would correspondingly increase the value of the existing bond portfolio. It’s worth noting that bond investments comprised approximately 16.6% of industry assets as of March 31, down from a peak of more than 22% in early 2022. So, although the impact of rates on investments can certainly be significant, it would perhaps be less influential to industry balance sheets compared to the recent past.
ACCUMULATED UNREALIZED LOSSES ON AVAILABLE FOR SALE SECURITIES
FOR U.S. CREDIT UNIONS
SOURCE: Callahan & Associates
Margin Management
A response by the Federal Reserve that raises interest rates could have further ramifications for credit union cost of funds. Credit unions that rely on borrowing to fund liquidity will pay higher costs. Currently, borrowing funds just 3.7% of assets, down from 6.0% in the fourth quarter of 2023. The cost of borrowing, however, is up to 5.1%, a steep increase from 1.8% in the first quarter of 2022, when the current Federal Reserve interest rate cycle began.
Secondly, an increase in interest rates will have consequences for cost of deposits. Savers will have more options available, and any credit union looking to capture deposits will have to raise rates to compete.
On the lending side, a hike in interest rates would likely mean more interest income on loans. However, if the Federal Reserve increases interest rates too much, it could price members out of the market entirely. On the other hand, if the Federal Reserve lowers interest rates, it could push margins lower yet also spur refinancing.
At the end of the day, economic fretting could be for naught. There’s a lot of policy uncertainty in Washington, and tariffs could be gone tomorrow. But with so much up in the air, it never hurts to prepare.