Know What is Stagflation

Stagnation Definition

Stagflation is a term that combines the terms “stagnation” 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.

Key Takeaways:

• Stagflation = inflation + stagnant growth + unemployment.

• Commonly triggered by supply shocks and policy missteps.

• Hard to manage with standard fiscal or monetary tools.

• Long-term solutions include boosting productivity and efficiency.

What Causes Stagflation?

• Supply-Side Shocks: A sudden rise in the cost of essential goods (like oil or energy) can push up prices across the economy. For example, the 1970s oil crisis, when oil prices surged, caused production costs to rise and slowed growth while inflation stayed high.

• Poor Economic Policies: Excessive money supply (too much printing of money) can fuel inflation. At the same time, rigid regulations, high taxes, or trade restrictions can slow down growth, creating the stagflation mix.

• Cost-Push Inflation: Rising wages, raw material costs, or import prices increase production costs. Companies pass these costs to consumers, raising prices while cutting jobs or investment, which hurts growth.

• Decline in Productivity: If businesses and workers become less productive, output falls. Lower output with rising prices results in stagnation plus inflation.

Why Stagflation is Bad?

• High Inflation Reduces Purchasing Power: When prices rise continuously while wages remain stagnant, the real value of money declines. People can afford fewer goods and services, leading to a fall in living standards.

• High Unemployment Creates Income Stress: Job losses or fewer employment opportunities during stagflation make it harder for households to sustain themselves, adding to financial instability and social stress.

• Policy Dilemma for Governments and Central Banks: Policymakers struggle because measures to curb inflation often worsen unemployment, while steps to boost growth tend to fuel inflation further, leaving no easy solutions.

• Investment and Business Growth Slow Down: Rising production costs and weak demand discourage businesses from expanding, reducing innovation, job creation, and overall economic momentum.

• Economic Instability and Low Confidence: With inflation, unemployment, and weak growth happening together, consumer and investor confidence falls sharply, further slowing economic recovery.

How is Stagflation Fixed?

• Balanced Monetary Policies: Central banks may cautiously raise interest rates to curb inflation while ensuring that credit does not become too expensive, which could worsen unemployment. The challenge is finding the right balance to control prices without hurting growth further.

• Targeted Fiscal Measures: Governments often use policies such as tax reliefs or subsidies in specific sectors to support production and reduce costs. These measures help ease inflationary pressures while creating jobs and stimulating demand.

• Boosting Productivity and Supply: Long-term solutions focus on improving efficiency, investing in infrastructure, and encouraging technological advancements. Increasing supply capacity helps reduce inflation while supporting economic growth.

• Structural Reforms: Reforms in labor markets, trade policies, and business regulations can help economies become more flexible. By reducing bottlenecks and improving competitiveness, these reforms address the root causes of stagnation.

• Diversifying Energy and Resources: Since stagflation often stems from supply shocks like oil price spikes, diversifying energy sources and reducing dependence on imports can stabilise prices and protect the economy from external shocks.

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.

Conclusion

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.

Explore the Share Market Prices Today