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What is Stagflation?


The term 'Stagflation' is included in the Economics edition of the Financial Dictionary. It's available on mazon in Kindle or Paperback version. See more details here.

Stagflation refers to the simultaneous problems of high unemployment, stagnated economic growth, and persistently high inflation. It is an unlikely scenario, as slowing economies typically reduce demand sufficiently in order to keep higher prices in check. When workers lose their jobs, they purchase less. Businesses are then usually forced to reduce their prices in order to convince remaining customers to buy. It is this typically slower growth in market economies that prevents inflation from running away.

Stagflation policies typically lead to hyperinflation. Central banks that expand the country’s money supply as the national supply is restricted do so by printing up additional currency. Monetary policies then create additional credit. This increases demand from consumers. It is the simultaneous supply restrictions that keep companies from producing enough to keep up with the rising demand.

Such a scenario happened in Zimbabwe back in 2004. Their government printed up so much currency that it pushed well beyond stagflation and evolved into ruinous hyperinflation. A stagflation in the United States only transpired in the 1970s. At the time the U.S. government expanded its dollars significantly to try to create additional economic growth. While they did this, President Nixon’s wage price controls severely limited business-produced supplies.

The name stagflation actually comes from the 1973 to 1975 era recession. In those six consecutive quarters, the U.S. GDP shrank in size. Inflation literally tripled in 1973 alone, jumping from a relatively tame 3.4% to 9.6%. In the time between February of 1974 and April of 1975, inflation stubbornly remained between 10% and 12%.

Experts today look back at the 1973 Arab-led oil embargo as the crisis that triggered first oil price inflation. At this time, OPEC nations drastically cut their oil exports to the United States, forcing prices to quadruple. The inflation from oil spread to many other parts of the economy dependent on oil and gasoline, such as shipping, rail, and trucking.

The mild recession of 1970 was the precursor to the problems. President Richard Nixon in his bid to be re-elected introduced as series of four fiscal and monetary economic policies that helped to ensure he won. These unfortunately also created the conditions for stagflation a few years later.

Nixon’s first mistake was the start of wage and price controls. U.S. businesses were unable to raise their final prices even as import costs were soaring. They could only respond by reducing costs via worker layoffs. That boosted unemployment and further slowed economic growth by lowering demand. Nixon secondly took the U.S. off the gold standard to stop an international run on American gold reserves. This only crushed the value of the dollar and created still higher import prices and yet more inflation.

In order to fight off the inflation, the Federal Reserve had no choice but to continue raising interest rates. These reached their peak of 20% by 1979. Because the Fed did this in an up and down motion, businesses became confused and chose to keep up higher prices.

Though stagflation has not yet reoccurred in the U.S., Americans became worried it might again in 2011. The Fed had begun employing aggressive expansive monetary policies to save the U.S. economy from the grips of the 2008 financial crisis and Great Recession. This caused many to fear that high inflation would return. The economy only grew at low levels form 1% to 2% at this time.

Economists observed stagflation was a viable risk if inflation rose while the economy continued to struggle. Instead, deflation became the serious concern of the day. Massive increases in global liquidity were used to try to fight off this opposite kind of problem.

The term 'Stagflation' is included in the Economics edition of the Financial Dictionary. You can get your copy on mazon in Kindle or Paperback version. See more details here.