ECONOMY

What is Stagflation and what does it mean?

DEFINITION

Stagflation is when there’s high inflation during a time of slow economic growth. Stagflation is a problem for policymakers, because tools used to fight inflation often increase unemployment.

The Key Takeaways

  • Stagflation is a combination of high inflation, stagnant economic growth and high unemployment.
  • This is due to the conflict between contractionary and expansive fiscal policies.
  • Stagflation was named during the 1973-1975 recession when GDP growth was negative in five quarters.
  • Stagflation will not be a problem today due to the changes in economic and policy conditions.

 

Definitions and examples of Stagflation

Stagflation occurs when there is stagnant growth in the economy, high unemployment and high . 1 This is an unnatural condition because inflation should not occur with a weakening economy.

In a normal economy, inflation is prevented by slow growth. In a normal market economy, the slow growth of the economy prevents inflation. Stagflation is only possible if government policies interfere with normal market functioning.

Note:

If you compare U.S. If you compare U.S.

The federal government used currency manipulation to stimulate economic growth. The government also restricted the supply by imposing wage-price control. 

In 2008, Zimbabwean government printed such a large amount of money that it went beyond stagflation to hyperinflation. 

 

How does Stagflation work?

When the government prints money, it is the most common cause of stagflation. The central bank can create credit through its monetary policy. Both inflation and an increase in the money supply can occur.

the same time, some policies slow down growth. This can happen, for example, when the government raises taxes. This can also happen when the central banks raise interest rates. Both stop companies from producing. Stagflation occurs when conflicting policies of expansion and contraction slow down growth, while creating inflation. 5 This is stagflation.

Stagflation in the 1970s

Stagflation was named during the recession of 1973-1975. Five quarters saw a negative gross domestic product. 2

GDP GROWTH Q1 Q2 Q3 Q4
1973 10.3% 4.4% -2.1% 3.8%
1974 -3.4% 1.0% -3.7% -1.5%
1975 -4.8% 2.9% 7.0% 5.5%

In 1973, inflation tripled from 3.6% to 8.7%. From February 1974 to April 1975, it rose between 10% and 12 %.

How did this happen? Experts blame the 1973 Oil Embargo. OPEC reduced its oil exports. Prices quadrupled, triggering inflation in oil.8

Note:

Stagflation was not caused by the 1973 oil embargo. It was actually a combination between fiscal and monetary policies that caused it.

The recession began in 1970 with a slight one. The GDP was negative during two quarters. Unemployment increased to 6.1%. President Richard Nixon ran for reelection. He wanted to increase growth without inducing inflation.

He announced three fiscal policies on August 15, 1971. He was re-elected thanks to them. The seeds of stagflation were also planted by them. A of Nixon’s speech reveals the announcement of major economic policy changes, known as the Nixon Shock.

Nixon Shock

Nixon’s Nixon Shock consisted of three Nixon actions.

  1. He implemented a 90-day price and wage freeze. He created a Pay Board and Price Commission that would approve any price increases after 90 days. It was convenient that it would keep prices under control until after the 1972 campaign for president. This is how he intended to control the inflation. 10
  2. Nixon imposed an import tariff of 10%. Nixon’s goal was to reduce the trade deficit while protecting domestic industries. Tariffs increased import prices instead. 11
  3. He removed the United States’ gold standard. This had tied the dollar’s price to a certain amount of gold ever since the 1944 Bretton Woods Agreement.

Note:

In Bretton Woods most countries agreed that the value of their currency would be based on either the price for gold or the U.S. Dollar. This had made the dollar a global currency.

The United States did not have as much gold at Fort Knox. Nixon then stopped redeeming dollars in gold. This caused the dollar’s value to plummet, which in turn drove import prices even higher.

The last two policies increased import prices and slowed the growth. Growth slowed further because U.S. firms couldn’t increase prices in order to stay profitable. They couldn’t reduce wages, so the only way they could cut costs was by laying off workers. This increased unemployment. Unemployment slows the growth of the economy and reduces demand for goods. Nixon’s attempts to control inflation and boost growth had the opposite impact.

Note:

Understanding the history of gold standard can help you to understand why gold was used as a backing for the dollar in the past and why it’s not today.

Stop-Go Monetary Policy

Federal Reserve attempts to combat stagflation have only made it worse. The Fed’s “stop-go”, or “stop-go”, monetary policy was confusing to businesses. Even when the Fed reduced rates, they kept prices high. This caused inflation to reach 13.3% in 1979. 16

Paul Volcker, the Federal Reserve chairperson of 1980, ended stagflation when he raised the rate to 20 percent. It came at a price. The 1980-1982 economic recession was caused by this policy. 

 

Could Stagflation Return?

In 2011, the public became worried about stagflation. They feared that the Fed’s expansive monetary policy, which was used to save the economy from 2008 financial crisis would lead to inflation.

It included the economic stimulus package and record levels of deficit spending. The stimulus package included record deficit spending. 18 At the same time, the economy grew only 1%-2%. 2 Many people warned about the danger of stagflation should inflation rise and the economy not improve.

The massive increase in global liquidity prevented deflation – a much greater risk. The Fed will not allow inflation to exceed its 2% core inflation target. 

Note:

It is unlikely that the unusual conditions which caused stagflation in the 1970s will recur.

First, the Fed has stopped using stop-go policies. It commits itself to a consistent course of action. Second, the removal from the gold standard of the dollar was an event that happened only once in a lifetime. Third, wage-price control that restricted supply would not even be considered in today’s world.

the authorAaron Krause

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