Stagflation: It expresses the situation in which stagnation (stagnation) and inflation occur at the same time.
What is Stagflation?
Stagflation is a situation in the economy where growth slows, unemployment remains high, and inflation is high or rising. Stagflation poses a dilemma for economic policy because actions to reduce inflation can increase unemployment. The term is a combination of the words stagnation and inflation and is usually attributed to Iain Macleod, who became the British Finance Minister in 1970. Macleod used the word in a speech to Parliament in 1965 at a time when Britain was experiencing both high inflation and unemployment. [1] [2] [3] [4]
What Causes Stagflation?
There are two main explanations for stagflation to occur. First, stagflation can occur when the economy faces a supply shock. For example, a sudden increase in oil prices can cause stagflation. An increase in oil prices may reduce demand and production, while raising production costs and consumer prices. This increases both inflation and unemployment. Supply shocks can also be other factors that constrain economic activity, such as natural disasters, wars, taxes or regulations.
Second, stagflation can occur as a result of the misapplication of monetary policy. Monetary policy is the central bank's influence on the economy by controlling the money supply and interest rates. The central bank can try to stimulate the economy by increasing the money supply or lowering interest rates. But if these policies go to extremes or persist for long periods of time, they can cause inflation. As inflation expectations rise, employers and workers may demand higher wages. This can further increase costs and prices. If the central bank decides to reduce the money supply or increase interest rates to control inflation, this could negatively affect growth and employment.
How to Prevent or Solve Stagflation?
Stagflation is a difficult process to prevent or resolve. Because the factors causing stagflation may require opposing policies. For example, a government that wants to increase demand to combat supply shocks may increase its spending or lower taxes. However, these policies can increase the budget deficit and debt and contribute to inflation. Similarly, a central bank that wants to tighten the money supply to fight inflation can raise interest rates. However, this policy can reduce investment and consumption and increase unemployment.
To deal with stagflation, economists often recommend policies aimed at improving the supply side. For example, policies such as increasing competition, increasing efficiency, encouraging innovation, liberalizing markets, facilitating trade can reduce the impact of supply shocks and support growth. It is also important to follow a reliable monetary policy to lower inflation expectations. The central bank can give signals to the markets by adhering to the inflation target and transparently. This can make wage and price adjustments more moderate.
Examples of Stagflation
Stagflation has been experienced repeatedly in the developed world since the second half of the 20th century. The best-known example is the stagflation that emerged as a result of the oil crisis in the 1970s. The four-fold increase in oil prices doubled both inflation and unemployment in developed countries. In this period, economic policy makers did not recognize the fundamental role of monetary policy in controlling inflation and took ineffective or harmful measures to combat inflation. [3]
Stagflation is not limited to oil crises. For example, in the 1980s Latin American countries entered stagflation while grappling with the debt crisis and hyperinflation. In the 1990s, Japan experienced a prolonged period of stagflation after the bubble burst and entered deflation. In the early 2000s, Argentina faced economic collapse and high inflation. After the 2008-2009 global financial crisis, some European countries approached stagflation.
Effects of Stagflation
Stagflation can cause serious damage to the economy and society. Stagflation lowers real incomes, reduces purchasing power, increases poverty and distorts income distribution. Stagflation increases unemployment, reduces job confidence, multiplies social problems and strains the welfare system. Stagflation complicates investment decisions, hinders capital accumulation, lowers economic potential and slows long-term growth. Stagflation can also endanger political stability. In stagflation, public dissatisfaction increases, trust in governments decreases, radical political movements strengthen and international relations are strained.