Stagflation is an economic cycle characterized by slow growth and a high unemployment rate accompanied by inflation. Economic policymakers find this combination particularly difficult to handle, as attempting to correct one of the factors can exacerbate another.
Once thought by economists to be impossible, stagflation has occurred repeatedly in the developed world since the 1970s oil crisis. In mid-2022, many were concerned that the United States might soon experience a period of stagflation due to imminent economic challenges.
Key Takeaways
- Stagflation is the simultaneous appearance in an economy of slow growth, high unemployment, and rising prices.
- Once thought by economists to be impossible, stagflation has occurred repeatedly in the developed world since the 1970s.
- Policy solutions for slow growth tend to worsen inflation, and vice versa. That makes stagflation hard to fight.
Economic Stagflation
Origins of the Term ‘Stagflation’
The term stagflation was first used by British politician Iain Macleod in a speech before the House of Commons in 1965, describing the combined effects of inflation and stagnation as a “stagflation situation.” The term gained prominence during the 1970s oil crisis, which saw several quarters of negative GDP growth, doubling of inflation, and reaching unemployment rates as high as 9%.
The effects of stagflation were later measured by the misery index, which combines the inflation rate and the unemployment rate to track its real-world implications.
History of Stagflation
Originally deemed impossible, the concept of stagflation dismantled prevailing economic theories, especially the Phillips Curve which suggested a trade-off between unemployment and inflation. The persistent appearance of inflation during periods of economic stagnation across developed nations proved that the relationship between inflation and unemployment was not as clear-cut as once believed.
Since the 1970s, inflation has occurred even during economic downturns. In all U.S. recessions over the past 50 years, consumer prices have continued to rise year-over-year.
What Causes Stagflation?
There is no real consensus among economists about the causes of stagflation, though several theories attempt to explain it:
Oil Price Shocks
One theory points to sudden increases in the cost of oil, which reduce an economy’s productive capacity. For instance, the 1973 OPEC oil embargo drastically increased global oil prices, escalating the costs of goods and contributing to a rise in unemployment.
Poor Economic Policies
Another theory suggests that poor economic policies, including harsh market regulations and missteps such as tariffs and price controls, can lead to stagflation. Examples include the policies enacted by former President Richard Nixon, which led to economic complications in the 1970s.
Abandonment of the Gold Standard
Other theories propose that the end of the gold standard and the shift to fiat currencies led to unrestricted monetary expansion and currency devaluation, thus contributing to stagflation.
Stagflation vs. Inflation
The persistent inflation seen during economic stagnation since the 1970s challenged pre-existing economic models. Critics argue that the supposed stable relationship between inflation and unemployment doesn’t hold up. Consumers and producers adjust their behavior to rising prices either in reaction to or in anticipation of monetary policy changes, causing inflation without corresponding decreases in unemployment.
Special Considerations
Many economists and policymakers now focus on managing accelerating and decelerating inflation rather than inflation itself. Simultaneous economic stagnation and rising prices seem to be part of the new economic standard during downturns, despite the historic anomaly in the 1970s.
The Underlying Factors
The stage for stagflation is often set by supply shocks, such as the disruptions seen during the COVID-19 pandemic affecting production across various industries, contributing to all the factors of stagflation: inflation, employment, and economic growth.
Why Is Stagflation Bad?
Stagflation creates a perilous trio of slower economic growth, higher unemployment, and increased prices. This defies economic logic, where rising prices shouldn’t occur when people have less money to spend.
Addressing Stagflation: Is There a Cure?
Though a definitive cure for stagflation remains elusive, the economic consensus is that increasing productivity to drive higher growth without stoking inflation could help. This would permit the tightening of monetary policy to control inflation, highlighting the need for proactive policymaking to stave off stagflation.
Related Terms: inflation, economic growth, high unemployment, Phillips Curve, Keynesian economics.
References
- Forbes. “Stagflation: Causes and When It Will Come”.
- UK Parliament. “Economic Affairs Volume 720: Debated on Wednesday 17 November 1965”.
- Smithsonian, National Museum of American History, Behring Center. “Energy Crisis”.
- U.S. Bureau of Labor Statistics. “Databases, Tables & Calculators by Subject: (Seas) Unemployment Rate”.
- Charles Schwab. “Is 1970s-Style Inflation Coming Back?”
- U.S. Bureau of Labor Statistics. “Historical CPI-U”, Page 4.
- United States Department of Labor. “Consumer Price Index: December 2008”.
- Office of the Historian, Foreign Service Institute, United States Department of State. “Oil Embargo, 1973–1974”.
- National Bureau of Economic Research (NBER). “NBER Macroeconomics Annual 2001, Volume 16”.
- Federal Reserve Bank of St. Louis. “Full Text of Papers of Richard M. Nixon : Address to the Nation Outlining a New Economic Policy: The Challenge of Peace”.
- Federal Reserve History. “Nixon Ends Convertibility of US Dollars to Gold and Announces Wage/Price Controls”.
- University of Toronto. “Jane Jacobs Among the Economists”.
