Everything You Need To Know About Stagflation

If the economy is sluggish, unemployment continues to be high, businesses are folding at alarming rates, and prices continue to rise…what's going on?

Welcome to stagflation. Stagflation is a condition of the economy in which stagnation causes inflation, unemployment is high, growth is flatlined, GDP stays constant or declines.

Stagflation is characterized by the co-existence of high inflation with high unemployment.

There are four types of stagflation:

  • Cost-push inflation, when the economy's productive capacity is inelastic and so increases in cost lead to a greater percentage increase in price. In this case, stagflation is caused by oligopolistic behavior from corporations. They begin to control pricing to keep profit margins high. In an economic recession, the unions attempt to maintain wages leading manufacturers to begin charging more for their products.

  • Demand-pull inflation, when there is a high demand for resources and a low unemployment level. In this case, stagflation occurs due to an increase in consumer expenditures with the economy's resources being unable to scale accordingly. This condition may arise from a rise in population or minimum wage laws.

  • Secondary inflation, when the general price level is fixed, and an increase in nominal money supply drives up the prices of goods. In this case stagflation occurs due to inflation which slows economic growth and creates joblessness. This can occur through printing too much money without producing additional goods.

  • Catch-22 inflation, when stagflation arises from an economy that is simultaneously experiencing both rising prices and falling output. This occurs mostly due to the government's contractionary fiscal policy in response to high aggregate demand.

The causes of stagflation can be attributed to many different factors:

  • Too much liquidity (excess supply of money) can cause demand-pull inflation.

  • Rapid credit growth, excessive government borrowing and spending, or the expansionary monetary policy used to mitigate a recession are all inflationary. They often lead to cost-push inflation or secondary inflation.

  • An economy may also experience stagflation when production of goods decreases while consumption increases. This is known as demand-pull inflation.

  • Cyclical stagnation in the labor market, high real interest rates, neglect of key industries can also lead to stagflation.

Stagflation is not an overall increase in price levels but rather a rise in some prices with others remaining low or falling. It commonly occurs when there are shortages caused by unemployment, with demand remaining constant. As manufacturers are unable to increase prices due to elastic or inelastic demands, they instead reduce production. This leads to an increase in unemployment which further reduces demand.

Stagflation can also occur when wages are forced up by public policy pushing costs higher without increasing productivity or creating new jobs. Furthermore, when consumer prices rise, demand falls. This exacerbates the problem of stagflation because less demand creates a vicious cycle in which unemployment increases and strike action results in manufacturers being unable to produce goods at a profitable price.

Generally, whatever is causing inflation will be causing stagflation. Demand-pull inflation caused by excess money supply too "easily" flowing through the economy, would cause both inflation and stagflation. The act of loosening credit standards to ensure economic growth (fiscal policy) is what causes demand pull inflation. However, that same fiscal policy can be responsible for stagflation when it occurs in conjunction with The cost-push factors mentioned above.

One possibility for stagnation causing stagflation is a devaluation of the nation's currency. This situation most often occurs in developing nations with low-value currencies and may force them to expend even more resources to sustain their economies under the new conditions.

In this scenario, stagflation is caused by mismanagement or neglect of key industries, such as oil or agriculture. With supply falling faster than demand, large portions of the population may be unemployed, while inflation in primary industries further reduces economic activity.

Government policies aimed at slowing inflation by raising interest rates or cutting spending can also inadvertently result in stagflation if they are undertaken during a period of weak demand. The resulting rise in unemployment and decline in consumer spending can outweigh the intended slowdown in inflation.

In addition, stagflation can result from a fall in production while demand remains constant. This is typically the case with underinvestment and low productivity growth in Western economies during recessions or depressions. In this scenario, there is a lack of aggregate demand but no inflationary pressure arising from a government deficit or from increases in the money supply. Consequently, prices may decline or remain stable.

Stagflation can also be caused by rapid growth in credit alongside continued demand for goods and services without a corresponding increase in available resources. The result is an inflationary contraction of economic output, which was observed during the financial crisis of 2008-2009.

To conclude, stagflation is the deteriorating combination of high inflation and high unemployment. It can be caused by various factors, including disinflationary pressures on the supply side, weak aggregate demand or a serious decline in production.

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