Stagflation: Definition, Causes, and Examples

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Inflation frequently occurs along with economic expansion, as people are willing and able to pay a higher price for goods and services. What happens when there is inflation amid a period of economic stagnation? Stagflation is the answer, and it is never good news. What precisely is stagflation, and what does it represent in economics? We’ll address these points in greater detail below.

What is stagflation?

Stagflation, as the term implies, is a term that combines two concepts: stagnation and inflation. This economic phenomenon occurs when economic growth slows (or stagnates) when unemployment and inflation both remain high.

Normally, slow economic development prevents inflation, as supply and demand dictate. As consumer demand declines, prices decrease in lockstep. This distinguishes stagflation from other economic phenomena, as it is produced by disruptive government policies interfering with normal market operation. It can be a significant issue for governments to resolve because the majority of initiatives aimed at reducing inflation result in an increase in unemployment and vice versa.

Economic definition of stagflation

By examining the origins of the phrase stagflation in economics, we can acquire a better understanding of its meaning. Stagflation was initially mentioned in the 1960s by British politician Iain Macleod, who described the economy as being in a state of’stagnation’.

Stagflation, on the other hand, is most closely connected with the 1970s recession, during which the United States endured five quarters of negative GDP growth following the oil crisis. Inflation doubled during this period, reaching double digits in 1974, corresponding with a 9 percent unemployment rate in 1975.

This ran counter to popular economic views at the time, notably macroeconomic ideas based on Keynesian theory. These stated that government actions aimed at lowering inflation resulted in increased unemployment, whereas policies aimed at lowering unemployment increased inflation. Stagflation demonstrated to economists that these hypotheses were not always right.

Stagflation’s causes

Therefore, since stagflation violates some of the most well accepted macroeconomic rules, what are its causes? One aspect contributing to this is the government’s currency overprinting, which increases the country’s money supply. Another possible explanation is that the central bank produces credit as a result of its policies. Both behaviours result in inflation as a result of the expansion of the money supply.

When these policies are combined with others that constrain growth, stagflation might result. A possible example is raising taxes and interest rates in an attempt to halt growth. Stagflation occurs as a result of the contradiction between policies aimed at slowing economic development while simultaneously increasing inflation.

Another theory is that stagflation is produced by supply shocks, which are rapid changes in supply. For instance, if the price of a commodity such as oil increases unexpectedly, prices rise proportionately but profits decline. The contradiction between rising prices and declining profitability results in stagflation.

Stagflation examples

Consider the economic condition in the 1970s as a prime example of historical stagflation. The US situation reflects all of the above-mentioned factors, creating a perfect storm of stagflation. During the 1950s and 1960s, the country saw rapid economic expansion, owing to the Federal Reserve’s efforts to stimulate demand and keep unemployment low. During the 1960s, however, earnings were unable to keep pace with the soaring cost of consumer goods. Supply shock was also a result of the oil embargo issue, with businesses suffering from extraordinarily high oil prices that had a knock-on effect. Demand dwindled, prices increased, and stagflation ensued.

Stagflation also happened in Zimbabwe in 2018 and 2019. A series of economic shocks prompted the government to flood the market with new money in order to address mounting national debt and economic output declines. Stagflation resulted from the combination of growing inflation and a poor economy.

Published by Zack Baharum

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