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Stagflation

An economic event characterized by a high inflation rate, slow economic growth, and steadily high unemployment

What is Stagflation?

Stagflation is an economic event in which the inflation rate is high, economic growth rate slows, and unemployment remains steadily high. This unfavorable combination is feared and can be a dilemma for governments since most actions designed to lower inflation may raise unemployment levels, and policies designed to decrease unemployment may worsen the inflation.

 

Stagflation

 

Causes of stagflation

There is no consensus among economists on the causes of stagflation. Each economics school offers its own view on its origins. However, two main theories may be derived: supply shock and poor economic policies.

The supply shock theory suggests that stagflation occurs when an economy faces a sudden increase or decrease in the supply of a commodity or service (supply shock), such as a rapid increase in the price of oil. In such situation, prices surge, making production costlier and less profitable, thus slowing economic growth.

A second theory states that a stagflation can be a result of a poorly made economic policy. For example, the government can create a policy that harms industries while growing the money supply too quickly. The simultaneous occurrence of these policies can lead to slower economic growth and higher inflation.

 

Example of stagflation

Stagflation is costly and difficult to eliminate, both in social and fiscal terms. There are only a few examples in history and the most notable one occurred in the 1970s in the United States.

The onset of stagflation In the 1970s was blamed on the US Federal Reserve’s unsustainable economic policy during the boom years of the late 1950s and 1960s. The Fed moved to keep unemployment low and boost overall demand for products and services in the 1960s. However, the unnaturally low unemployment during the decade triggered something called a wage-price spiral.

The OPEC oil embargo in 1973 also contributed to the unwanted economic event in the US. Industries across the country suffered from excessively high oil prices and shortages. Demand fell to new lows and industrial output suffered.

 

More resources

CFI offers the Financial Modeling & Valuation Analyst (FMVA)™ certification program for those looking to take their careers to the next level. To continue learning and advancing career, these additional resources will be helpful:

  • Inelastic Demand
  • Law of Supply
  • Market Economy
  • Purchasing Power Parity

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