Stagflation is a term that combines the terms “stagflation” and “inflation.” It refers to a state of the economy marked by poor growth and high unemployment (economic stagnation), as well as increasing prices (inflation).
In a speech to the House of Commons in 1965, British Conservative Party politician Iain Macleod used the word for the first time: Stagflation was first thought to be impossible by many economists. After all, the unemployment rate and the rate of inflation usually move in opposing directions. Stagflation is real, and it can have a disastrous impact on the economy, as the 1970s’ “Great Inflation” era showed.
Inflation vs. stagflation
Although stagflation and inflation are closely connected, they should not be mistaken. Inflation is defined as a long-term rise in the average price level of all products and services in an economy, not just a few of them. When the money supply expands faster than the economy’s ability to generate goods and services, inflation occurs.
When inflation occurs in concert with poor economic development and significant unemployment, stagflation occurs. Normally, these economic circumstances do not coincide at the same time. Unemployment and inflation have a strong negative relationship. As a result, as unemployment rises, inflation typically falls, and vice versa. This link isn’t always steady or predictable, as the stagflation of the 1970s demonstrated.
What creates stagflation in the first place?
Stagflation is the result of a perfect storm of economic ills: poor growth, high unemployment, and high prices. Supply shocks and fiscal and monetary policy are the two main drivers of stagflation, according to economists. A supply shock occurs when the economy’s ability to produce products and services at predetermined prices is reduced. Throughout the pandemic, for example, there have been supplying shocks in:
Services, as people postponed elective operations and other health-care procedures Labor, with fewer people working Goods, such as semiconductor shortages, which began even before the pandemic. Stagflation may also be caused by poor fiscal and monetary policies.
What do the effects of stagflation look like?
The economy is under tremendous strain due to the trifecta of weak growth, rising unemployment, and rapid inflation. Stagflation affects homes by causing individuals to earn less money while spending more on everything from food to medication to housing and consumer goods. As consumer spending slows, business revenue falls, increasing the economy’s overall impact.
The post-World War II economic boom started to erode in the late 1960s. Unemployment rates and inflation rose as the US confronted more foreign competition, a loss of industrial jobs, and an enormously costly war in Vietnam.
Attempts by the Federal Reserve to combat stagflation via monetary policy have only exacerbated the problem. The Federal Reserve increased the federal funds rate to combat inflation between 1971 and 1978, then decreased it to combat the recession. Stop-and-go policies perplexed individuals and companies, resulting in increased inflation.
The United States, on the other hand, had far greater obstacles. Starting in 1973, an oil embargo imposed by the Organization of Petroleum Exporting Countries (OPEC) on the United States caused prices to rise. Businesses passed those costs on to customers, but they also reduced output (raising unemployment) as a result of the supply shock. The price of a barrel of oil doubled, then quadrupled, driving up inflation and putting even more pressure on the already-struggling US economy.
Stagflation was a major problem in the United States throughout the 1970s, and there are fears that it may resurface when the economy recovers from the pandemic-induced slump. Economists are keeping a careful eye on GDP, unemployment, and inflation trends, as well as possible stagflation triggers including supply disruptions and central bank actions. Some people are concerned about the high energy costs that have been in place for a long time.