CandleFocus Glossary Editor
Stagflation is an economic dilemma, wherein a country experiences high unemployment rate coupled with a stagnant or negative rate of economic growth and rising inflation. It is marked by a combination of rising prices and falling demand – a disheartening situation that previously seemed to be logically impossible.
Typically, economists believed that it was impossible for an economy to suffer from both high unemployment and high inflation at the same time. The cause of stagflation is complex, but an oversimplified explanation seems to be a mismatch between supply and demand.
In periods of economic growth, prices rise slowly as a result of increased production and production costs. When growth slows and unemployment rises, costs remain high yet demand decreases. This places upward pressure on prices, creating an economic slowdown of falling demand and rising prices -- the relatively new economic phenomenon that is referred to as ‘stagflation’.
Similar to the Great Depression of the 1930s, the stagflation of the 1970s has had a profound impact on the course of modern economic history. Predictably, it had a marked effect on economies across the world, leading central banks in some countries to focus on policies that would combat inflation and unemployment simultaneously.
In theory, this is an extremely difficult balance to achieve. Common solutions to unemployment, such as lowering interest rates, are really only effective solutions to stimulate economic growth when bottlenecks in the supply chain are present. Low interest rates also lead to an outpouring of liquidity and consequently higher prices in the economy. Similarly, policies aimed at controlling inflation, such as higher interest rates, tend to hamper economic growth by making it more expensive to borrow.
The most effective way to battle stagflation involves a combination of government policies aimed at increasing both the demand and supply side of the economy. Fiscal policy is key here, with government investment being used to bring the cost of goods and services down while simultaneously encouraging business activities. This could involve targeted tax breaks, targeted boosts to public spending and incentives for private sector activities.
Some economists note that one of the most successful attempts at addressing stagflation was employed by British PM Margaret Thatcher in the 1980s. She reduced the size of the public sector by cutting public sector spending and was successful in bringing about a period of economic growth.
The most important lesson we can learn from stagflation is that sustainable economic growth has to be created through long-term strategies. The government has to undertake initiatives to create jobs and encourage investments, while at the same time curbing inflation in the economy. In essence, governments have to hit a ‘sweet spot’ in their economic policies to bring about growth and development in their economy.
Overall, stagflation is a complex economic phenomenon that has been experienced multiple times since the 1970s and it could continued to struck economies in the future. Consequently, economists and policy makers must be aware of the potential dangers that come with this phenomenon and equip themselves with the right policies to combat it.
Typically, economists believed that it was impossible for an economy to suffer from both high unemployment and high inflation at the same time. The cause of stagflation is complex, but an oversimplified explanation seems to be a mismatch between supply and demand.
In periods of economic growth, prices rise slowly as a result of increased production and production costs. When growth slows and unemployment rises, costs remain high yet demand decreases. This places upward pressure on prices, creating an economic slowdown of falling demand and rising prices -- the relatively new economic phenomenon that is referred to as ‘stagflation’.
Similar to the Great Depression of the 1930s, the stagflation of the 1970s has had a profound impact on the course of modern economic history. Predictably, it had a marked effect on economies across the world, leading central banks in some countries to focus on policies that would combat inflation and unemployment simultaneously.
In theory, this is an extremely difficult balance to achieve. Common solutions to unemployment, such as lowering interest rates, are really only effective solutions to stimulate economic growth when bottlenecks in the supply chain are present. Low interest rates also lead to an outpouring of liquidity and consequently higher prices in the economy. Similarly, policies aimed at controlling inflation, such as higher interest rates, tend to hamper economic growth by making it more expensive to borrow.
The most effective way to battle stagflation involves a combination of government policies aimed at increasing both the demand and supply side of the economy. Fiscal policy is key here, with government investment being used to bring the cost of goods and services down while simultaneously encouraging business activities. This could involve targeted tax breaks, targeted boosts to public spending and incentives for private sector activities.
Some economists note that one of the most successful attempts at addressing stagflation was employed by British PM Margaret Thatcher in the 1980s. She reduced the size of the public sector by cutting public sector spending and was successful in bringing about a period of economic growth.
The most important lesson we can learn from stagflation is that sustainable economic growth has to be created through long-term strategies. The government has to undertake initiatives to create jobs and encourage investments, while at the same time curbing inflation in the economy. In essence, governments have to hit a ‘sweet spot’ in their economic policies to bring about growth and development in their economy.
Overall, stagflation is a complex economic phenomenon that has been experienced multiple times since the 1970s and it could continued to struck economies in the future. Consequently, economists and policy makers must be aware of the potential dangers that come with this phenomenon and equip themselves with the right policies to combat it.