Defn

In economics, the term stagflation refers to the situation when both the inflation rate and
the unemployment rate are high. It is a difficult economic condition for a country, as both
inflation and economic stagnation occur simultaneously and no macroeconomic policy
can address both of these problems at the same time.

The worst of all possible economic worlds: A stagnant or slow growth economy coupled
with increasing inflationary pressures.

Sluggish economic growth coupled with a high rate of inflation and unemployment.

In Economic terms:
Stagflation = Stagnation + Inflation

Stagflation occurs when the economy isn't growing but prices are.

Inflation & Deflation are two major vices of capitalistic economy. In inflation too much
money chasing too few goods, whereas, in deflation too much over production is
observed. The term Stagflation refers to the situation where the prices & level of
unemployment increase continuously and the result is very slow economic growth.

History

stagflation is generally attributed to British politician Iain Macleod, who coined the term
in a speech to Parliament in 1965.[2][3][4] The concept is notable partly because, in postwar
macroeconomic theory, inflation and recession were regarded as mutually exclusive, and
also because stagflation has generally proven to be difficult and, in human terms as well
as budget deficits, very costly to eradicate once it gets started. In the political arena a
simple measure of Stagflation termed the Misery Index (derived by the simple addition of
the inflation rate to the unemployment rate) was used to swing Presidential elections in
the United States in 1976 and 1980.

This threat of stagflation is not based on excessive government deficits and loose
monetary policy. So macro policies like raising interest rates will be counterproductive.
Instead the focus has to be on specific actions to control commodity prices. Strategies
include preventing financial players from involvement in commodity futures markets as
well as banning over the counter derivatives trading in futures. Commodity boards,
buffer holdings and other measures to stabilise prices are also important to ensure
cheaper access of developing countries to supplies of such commodities.

If such stagflation does occur, it will reflect the attempt of the global financial class to
increase its share of global income even in the wake of financial crisis. Most of the
declining share would then be of wage incomes especially in the developing world.
Therefore attempts to resolve this in a less oppressive way require a reduction of the
political power of finance.

Such a political consensus in favour of restricting finance is unlikely to occur without

even more extensive economic crisis. As it happens, this is still very much in the cards.

Stagflation is an economic trend in which inflation and unemployment rise while general
growth of the economy is slow. It can be difficult to correct stagflation, because focusing
on one aspect of the problem can exacerbate other aspects. Many governments try to
avoid stagflation through fiscal policy, by promoting even and healthy growth and
attempting to prevent inflation. If stagflation continues long enough, it will trigger an
economic recession and an ultimate self-correction.

One of the most well-known examples of stagflation in the United States occurred in the
1970s, during the oil crisis. Several other nations including the United Kingdom
experienced stagflation during this period, as high oil prices contributed to general
inflation while employment and the domestic economy remained sluggish. In the United
States, the Federal Reserve Bank ultimately stepped in, freezing the money supply and
triggering a recession.

The causes of stagflation are widely debated. Some economists believe that excessive
government regulation, for example, contributes to stagflation. Others believe that it may
be triggered by outside events, such as a sudden climb in the price of a commodity like
oil; this is known as shock theory. Whatever the cause, stagflation may take some hard
work to correct, and it can be difficult to ride out a period of stagflation.

Stagflation is back in the headlines but the term is being misused

The stagflation that began in the late 1960s and resulted from this attitude was indeed
dreadful-from 1969 to 1982, inflation averaged 7.5% annually and unemployment 6.4%.

What’s renewed interest in stagflation is the latest consumer price index (CPI), the
government’s main inflation indicator.

Stagflation is when the domestic economy of a country fails to grow but prices rise
anyway. ("stagnation" with "inflation")

According to Barron:

"STAGFLATION term was coined by economists in the 1970s to describe the

unprecedented combination of slow economic growth and high unemployment
(stagnation) with rising prices (inflation).
The principal factor was the four-fold:

1) raise in General Price Level

2) Increase in Unemployment Level

3) Fall in Domestic Gross Production

4) Poor Economic Growth

In the situation of Stagflation the continuous raise in price level is observed. Consumer
faces burden & the producers earns extraordinary profits. They respond by enhancing
their products to earn the maximum profits.

Interest rate has raised in such situation hence the fiscal and monetary policies aimed at
stimulating the economy and only exacerbated the inflationary effects. Hence the
situation has created a hard dilemma for the central banks. They attempt to head off
inflation or address slowing the growth rate.

The central banks usually raise the level of reserve ratio, bank rate & rate of interest etc
so that the increase of prices can be checked.

An economy is understood to be stagnant if it experiences a long-term period of

economic growth that is less than 2-3%. Inflation is defined as a general increase in
the price of all goods and services as measured by the Consumer Price Index.

Governments employ a mix of fiscal and monetary policies to correct unfavorable

economic trends and to foster growth. Reducing the Fed funds rate leads to a
lowering of interest rates by banks that promotes borrowing and more economic
activity. The increased money supply can also fuel inflation. On the other hand,
increasing the Fed funds rate leads to a contraction of the economy. This results in
lowering inflation but also slows down the economy. When stagflation happens
there is both inflation and reduced economic activity. Policymakers are challenged
to implement actions that simultaneously address both these issues.

What Causes Stagflation?

There are two main reasons that are believed to cause stagflation. The first relates to a
sudden and unexpected rise in the price of a commodity, such as the oil price shocks
experienced in the US in the 1970s. This leads to a general rise in production costs
leading to price increases. As the purchasing power of the currency decreases, people
cannot afford the cost of some goods and services. They limit their purchases to meeting
basic needs. Businesses respond by scaling back. This leads to increased unemployment
and a slowing down of the economy. The result is stagflation.
Stagflation is also cited to result when governments implement macroeconomic policies
that are not suitable. Excessive regulations can curb economic growth. Expansionary
policies that are used to correct such situations can lead to inflation and increased
unemployment. The economy slows down resulting in stagflation.

In addition to fiscal and monetary factors, factors such as labor market conditions and
strength of trade unions, international events, expectations people have about inflation
and supply constraints can also distort costs and prices within an economy leading to
increased inflation that can ultimately lead to stagflation.

1. cost-push factors
2. the labor market conditions and trade union activity can contribute to inflation if
trade unions play an important role in the labor market
3. sociological factors
For example in UK and in some other advanced market economies the trade union
militancy and excessive wage bargaining power has been very high and they have
higher rates of inflation than other countries which have lesser trade union power
in the labor market. That is, inflation factors can be other than monetary factors or
money supply factors in an economy. In addition, monetary policy to reduce
inflation if inflation is caused primarily by cost-push factors it was found that to
control inflation by monetary policy alone was ineffective. In effect, cost push
factors can be an important inflationary cause in many countries and there may be
a combination of causes of inflation in varying degrees from one country to the
next.

4. Oil price increase

5. imperfection in the goods market,
6. competition and other monetary mismanagement
7. fiscal mismanagement can be cause
8. short supplies of essential commodities (such as oil)
9. too fast a rise in money supply (which in turn usually reflects government
policy).

How is Stagflation Corrected?

According to Keynesian theory, inflation and economic stagnation cannot happen

simultaneously. Using monetary policy to control one factor, say inflation, can lead to
further economic woes.

Policymakers use a combination of fiscal and monetary policies to control stagflation.

While increased spending by the government or reduced taxes stimulate growth,
monetary policies are used to manage liquidity in the system and to control inflation.
Governments also aim to stabilize key institutions so as to retain public confidence in
their operations.
Measures to reduce costs, such as more efficient design of processes and machinery as
well as alternative technologies and conservation of resources can also contribute
favorably to reverse stagflation.

How Do We Respond to Stagflation?

Stagflation leads to a drop in consumer confidence and uncertainty about how long this
condition would last. Our best response as consumers is to make wiser decisions about
budgeting and investing.

Financial experts advice us to maintain an emergency fund of 3-6 months of living

expenses at all times. This advice is even more relevant in a slow economy. Even if funds
are available, consider carefully before purchasing high value items or a second home.
Stagflation increases the risk of job loss. So use every opportunity to sharpen job skills.
Ensure that credit card or other high-interest bearing debt is under control. Paying down
credit cards and maintaining about two cards is a wise move.

In summary, stagflation is caused by macroeconomic events that are not within our
control. The interim period before the situation is corrected can call for sacrifices on the
part of consumers. Careful planning in both spending and investing can help us see
through such downturns.

The Cause of 1970s Stagflation

Supply shock view

• OPEC’s oil price hike was the main cause. Aggressive wage hikes also
contributed.
• Expansionary fiscal & monetary policy accommodated and softened the blow.
Global monetarist view
• As US lost monetary discipline, the fixed rate regime collapsed in 1971-73 and
USD fell.
• Major central banks expanded money to counter appreciation pressure, causing
global liquidity glut in the early 1970s.
• Oil shock was the result, not the cause, of global inflation.

How Is It Measured?

Stagflation is not measured by a single data point, but rather by examining the direction
of a variety of indicators over an extended period of time. While the direction of a single
indicator does not necessarily indicate the potential for or the presence of stagflation,
when the indicators are considered in aggregate, a picture of the economy's health
emerges. When an increase in certain indicators occurs over a long period of time and is
coupled with declines in other indicators, stagflation is said to be occurring.
To Stop Stagflation

The above examination of factors producing stagflation suggests these remedies:

• Prioritize our internal security measures based upon likelihood and magnitude of
threats.
• Restrict our national guard to internal security duties, except for congressionally
declared foreign emergencies.
• Support creation of an international justice and peace capability, so we aren’t tempted
to police the world.
• Downsize our military to orient only to probable military challenges.
• Bring our troops home from Iraq.

• Reduce consumption of foreign oil through conservation, recycling and alternative

energies.
• Invest in producing alternative energies
• Invest in producing vehicles and other machines which conserve energy and use
sustainable energy.
• Use grains to provide food instead of fuel.
• Protect our environment to deduce public costs.

• Invest to maintain and enhance our physical infrastructure.

• Invest to provide quality care and education to every child and person from birth
throughout their life.
• Provide sufficient educational assistance to qualified students.
• Invest to provide quality cost controlled health care to all.
• Allow our government to bargain with health care providers.

• Substitute public health care insurance for private insurance.

• Substitute consumption taxes for job (FICA) taxes.
• Restore and enhance worker rights, including especially the rights to unionize and
bargain.
• Create a fair progressive income tax which doesn’t contribute to unwarranted financial
inequality.
• Create measures to provide adequate incomes to workers and disabled people.

• Regulate industries and businesses to restore appropriate competition; reduce

corruption; prevent bubbles; and protect our employees, investors, suppliers,
consumers and environment.
• Eliminate privatization of government work, with no-bid contracts to campaign
contributors.
• Eliminate both Republican and Democratic earmarked pork contracts to campaign
contributors.
• Regulate foreign trade to require competitors to improve their labor, consumer and
environmental standards.
• Ease immigration of needed students and workers to our county.

The government can be a problem through doing too much or too little. It is a necessary
solution to many of our challenges

Diagram of Stagflation

The diagram shows that the stagflation causes the price level to rise from P1 to P2.
Output falls from Y1 to Y2

How To Solve Stagflation?

It is not easy. For example You could use Monetary policy to reduce inflation. Higher
Interest rates increase the cost of borrowing and will reduce AD. This will be effective
for reducing inflation, but, it will cause a bigger fall in GDP.

If the MPC cut interest rates they may increase GDP, but would make inflation worse.
Therefore demand side policies cannot solve stagflation they can only solve one
particular aspect.

The only solution to stagflation is to increase AS through supply side policies. However,
these will take a long time. Also if the cost push inflation occurs because of a global
increase in the price of oil and food, there is little that the UK government can do about
it. There are concerns about stagflation in the UK but a solution is not easy. However,
often cost push inflation is a temporary affair e.g. rising energy prices may not continue
for ever (hopefully)

OTHER COUNTRIES WHICH WERE AFFECTED BY STAGFLATION

U.S, U.K, Pakistan, South Africa, Europe, Australia.

SLOWFLATION

An economic state characterised by slow growth and high inflation. [Cf. stagflation.]

A phrase coined to describe the state of the economy, in which growth is slow and
inflation is high.

Similar to stagflation which was particularly prevalent in the 1970s in the UK, though as
opposed to growth being stagnated it is still in positive territory, albeit 'slow'.