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Stagflation: Inflation Plus Stagnation

stagflation
Stagflation occurs when prices are rising, but the economy is sluggish and the unemployment rate is high.
Credit: sheelamohanachandran2010 / Shutterstock.com

Having only been around since the 1970s, stagflation is one of the more rare economic conditions. Since it is so uncommon, few understand just how destructive a period of stagflation can be.

What is stagflation?

Rarely is high inflation accompanied by a period of stagnation, but that is exactly what stagflation is. The unusual situation occurs when despite rising prices, economic growth is sluggish and unemployment rates are high. This is abnormal because generally a slow economy reduces the demand for goods and services, which in turn drives prices down.

Stagflation is considered devastating because prices are rising at the same time as the unemployment rate, making conditions even worse on people without a job or those who live on an already tight budget. In addition, once stagflation starts, it is extremely difficult to stop. Generally, when economic growth is slow the Federal Reserve uses its monetary policy authority to lower interest rates or increase the money supply to get the economy flowing again. However, that only makes the inflation aspect of stagflation worse. Consequently, any action taken by those charged with controlling the economy has negative consequences. The only way to curb stagflation is through a careful combination or both monetary and fiscal policy

What causes stagflation?

Economists have several different theories on what causes stagflation. Keynesian economists believe it is triggered by a serious shock to the supply of energy or food, such as a dramatic increase in oil prices. Monetarists, on the other hand, blame stagflation on a rapid increase in a country's money supply, while those who favor supply-side economics think it is caused by a combination of stringent business regulations and high taxes. Generally, it is a mixture of all three that sends a country's economy spiraling into a stagflation.

History of stagflation

The term was first coined in the 1970s when the United States began experiencing inflation in the midst of a recession. Many blame the economic policies of Richard Nixon for the economic downturn. Not wanting to run for re-election while the economy was tanking, Nixon encouraged the Federal Reserve to increase the money supply at the same time he was imposing a series of wage and price controls. While the moves were initially successful, a rapid increase in oil prices sent the economy spiraling. The combination of the fiscal and monetary policies with the rising oil prices resulted in double-digit inflation rates in 1973 and 1974 and unemployment rates jumping from 5 to 9 percent, all while the economy slowed to a crawl.

Stagflation continued through both the Gerald Ford and Jimmy Carter administrations. It wasn't until 1981 that the situation began to improve. It was then that President Ronald Regan instituted his plan for dealing with stagflation –Reagananomics – which focused on increasing government spending while also cutting taxes. That was the last time the United States was faced with stagflation. The last country to experience a full-fledged stagflation was Zimbabwe in 2004.

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