Stagflation

Stagflation (stagnation + inflation) – price growth in a country with stagnation in the economy.

There is a high level of unemployment and slow economic growth (stagnation), as well as a constant rise in the price level (inflation). Basically, stagflation is a decrease in gross domestic product (GDP) and an increase in prices (inflation).

Understanding Stagflation

In the 1960s Great Britain was under economic stress. That's when the word "stagflation" appeared. It was first used by the politician Ian MacLeod. His speech in the House of Commons highlighted the stagnation and inflation in the country. He called their combination a "stagflation' situation".

In the 1970s, the word reappeared in describing the recession after the oil crisis. At the time, the U.S. had been showing negative GDP growth for almost 1.5 years.

In 1973, inflation doubled. In 1974 it reached double-digit numbers. In May 1975, the unemployment rate reached 9%.

During stagflation (inflation and unemployment rise), an indicator of the level of people's bad feeling about the economy's decline appeared. This indicator was called the unhappiness index. The unhappiness index is the sum of the inflation rate and the unemployment rate.

History of Stagflation

For a long time, there was no mention of stagflation in economic theories of academic and political societies, because it was not included in economic models. The compromise between unemployment and inflation in Phillips' economic theory was the macroeconomic policy within Keynesian economics.

In the 20th century, economists began to look at deflation risk more in detail. They noticed that unemployment reduction measures make inflation go up, and most inflation reduction measures make the lives of the unemployed people worse.

In the middle of the 20th century stagflation came to the developed countries, disproving the economists' theory. Real economic data disputed conventional economic theories and policy prescriptions.

Since then, inflation has been a constant companion of economies around the world. It is preserved with both slow and negative economic growth. Consumer price levels in the U.S. have been rising steadily during recessions for the past 50 years. The only exception to this was in 2008. There was a drop in energy and transport prices. That was the point of the financial crisis. However, prices for general consumer goods continued to rise.

Stagflation theories

Economists consider stagflation as a failure of the dominant economic theories, so it was necessary to find ways to explain it through the terms of existing theories. Thus, several theories of stagflation have been suggested.

Oil prices. One of the theories suggests that stagflation occurs when the price of oil rises sharply, reducing the productive capacity of the economy. In October 1973, the Organization of the Petroleum Exporting Countries (OPEC) embargoed Western countries. There was a sudden rise in world oil prices, in the cost of goods, and in unemployment.

The costs of transportation were rising. It became expensive to produce and deliver goods. Prices have been rising even while people are being fired. Opponents of this theory point out that oil price jumps were not associated with periods of inflation and recession, as in the 1970s.

Poor economic policies. The second theory considers stagflation as a consequence of bad economic policy. Stagnation and inflation could be caused by strict regulation of markets, goods, and labor. For example, the policies of former President Richard Nixon are treated as a precondition for a period of stagflation. To prevent price increases, salary levels were frozen and tariffs on imports were imposed. It lasted 90 days.

After the control easing, an oil deficit occurred and the rise in prices accelerated. Economic chaos has emerged.

This theory looks attractive to many economists, but it does not explain the simultaneous increase in inflation and unemployment, and the subsequent period of recession.

The Gold Standard. Other theories talk about the influence of monetary factors on stagflation. Under President Nixon, the Bretton Woods system (the provision of the currency unit with gold) of international finance stopped to exist. After that came the fiat basis of monetization appeared. Most of the practical limitations of monetary expansion and currency devaluation disappeared.