Description
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Context
- Concept explained in “The Hindu”
What is Stagflation?
- Stagflation or recession-inflation is a combination of stagnant economic growth, high unemployment, and high inflation.
- It presents a dilemma for economic policy, since actions intended to lower inflation may exacerbate unemployment. It’s an unnatural situation because inflation is not supposed to occur in a weak economy.
- Iain Macleod, a Conservative Party MP in the United Kingdom, is known to have coined the phrase during his speech on the UK economy in November
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Typically, rising inflation happens when an economy is booming — people are earning lots of money, demanding lots of goods and services and as a result, prices keep going up. When the demand is down and the economy is in the doldrums, by the reverse logic, prices tend to stagnate (or even fall).
But stagflation is a condition where an economy experiences the worst of both worlds — the growth rate is largely stagnant (along with rising unemployment) and inflation is not only high but persistently so.
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Causes of stagflation
- Oil price rise: Stagflation is often caused by a supply-side shock. For example, rising commodity prices, such as oil prices, will cause a rise in business costs (transport more expensive) and short-run aggregate supply will shift to the left. This causes a higher inflation rate and lower GDP.
- Powerful trade unions: If trade unions have strong bargaining power – they may be able to bargain for higher wages, even in periods of lower economic growth. Higher wages are a significant cause of inflation.
- Falling productivity: If an economy experiences falling productivity – workers becoming more inefficient; costs will rise and output fall.
- Rise in structural unemployment: If there is a decline in traditional industries, we may get more structural unemployment and lower output. Thus we can get higher unemployment – even if inflation is also increasing.
In a nutshell,
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Note:
The idea of stagflation is closely linked to the Phillips curve which tried to establish that there was a negative empirical relationship between unemployment and inflation. That is, according to the Philips curve, when unemployment is high, inflation is low and when unemployment is low, inflation is high.
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Must Read,
Important Economic Curves: https://www.iasgyan.in/blogs/important-economic-curves-for-upsc
Inflation: https://www.iasgyan.in/blogs/inflation-all-you-need-to-know
https://indianexpress.com/article/explained/oil-prices-rise-stagflation-india-russia-ukraine-war-7804516/
