What is Stagflation in Economics| What are the Causes and Effects of Stagflation

What is Stagflation?

Stagflation is a term used to describe an economy that has simultaneously experienced high inflation and low economic output. The 1970s can be seen as the time when stagflation was first recognized, with many developed economies experiencing rapid inflation and high unemployment due to an oil shock.

“The average price of gas in America reached $3.40 per gallon by the end of January 2008.”

This statement is a prime example of how stagflation affects not just one generation but future generations too.

Supply theories attribute stagflation to sudden disruptions in resource scarcity! Unfortunately, stagflation is a nasty thing to deal with. It means that prices are going up even as the gross domestic product goes down. Experts believe it stems from too much deficit spending and not enough job growth in the economy.

Is stagflation good or bad?

Stagnation is a bad situation. Stagflation is a period of time when the economy faces both economic stagnation and inflation at the same time. In other words, it’s an unpleasant combination of high unemployment rates with rising prices for goods and services.

What Causes Stagflation

• Oil price rise Stagflation is often caused by a supply-side shock. The oil price rise is likely the cause of stagflation. As it rises, prices for everything from transportation to food will go up in tandem with it, and this increase in costs causes short-run aggregate supply to shift left as well. This leads to higher inflation rates that are more difficult for central banks to control with their monetary policymaking tools.
• When the government and central bank get into a tug of war with their policies, there can be major consequences. When they start working in opposition, it causes stagflation where there is slow growth coupled with high inflation.
• Powerful trade unions can trigger stagflation. If trade unions have strong bargaining power – they may be able to bargain for higher wages, even in periods of lower economic growth. In the face of rising prices or inflation, workers will protest less about their wages if they know that it’s better than what they could get elsewhere. Higher wages are a significant cause of inflation
• If people are out of work, the economy slows down. This is because if there’s a lack of jobs and growth in other sectors, this can cause stagflation. For example, if traditional industries decline we may see more unemployment with less output.
• If an economy experiences falling productivity, costs will rise and output will fall. Falling productivity can cause stagflation. If workers become more inefficient, the production of goods and services in the economy will decrease and there may be a situation where wages are stagnant or even decreasing while prices continue to go up. This is what we know as stagflation – a simultaneous downturn in both economic growth (economic stagnation) and inflation which can lead to recessions because it leads people to put off purchases for fear that they’re going to get stuck with higher-priced goods later on. In 2008, the Zimbabwean government’s money printing presses ran nonstop and it went beyond stagflation into hyperinflation.

Effects of Stagflation

Stagflation occurs when an economy experiences a combination of low growth and high inflation. These factors can work together to slow down the economy by causing people to spend less money because prices are rising.

Stagflation Example/ Stagflation 1970s

In the mid-1970s, stagflation was used to describe the period when the United States faced a prolonged slump and high unemployment along with rising inflation. It was mainly on the back of OPEC’s decision to cut oil supplies. As a result, the oil prices reached new heights and hampering productive capacity. The US Fed tried to address the issue by rate cuts and boosting money supply, but output couldn’t rise much due to low productivity and oil shortage

So, when you give a whole lot of money to people with even more money than they had before and then that extra money just triggered inflation. And this peculiar situation got the popular Keynesian philosophy thinking about whether or not it was on to something. According to the Keynesian philosophy, if inflation has an inverse relationship with unemployment in any given society, then it should also have an affirmative relationship with economic growth.

Solutions to Stagflation

• The only real solution to stagflation is in the form of supply-side policies. These go one step further than traditional Keynesian policies by not just focusing on demand but also production and efficiency. This allows for greater growth without inflation, which will better protect our economy from market shocks such as recessions and global price fluctuations.
• If the world wants to avoid a future of crippling stagflation, we need to find a way around oil dependency. Adjusting our dependency on oil can help maintain steady economic rates and reduce the danger of volatility.
• Monetary policy is always a tough balancing act. It can try to cut inflation (higher interest rates) or increase GDP growth (cut interest rates). Monetary policy cannot solve both inflation and recession at the same time.