DEFINITION of 'Stagflation'

A condition of slow economic growth and relatively high unemployment – economic stagnation – accompanied by rising prices, or inflation, or inflation and a decline in Gross Domestic Product (GDP). Stagflation is an economic problem defined in equal parts by it’s rarity and by the lack of consensus among academics on how exactly it comes to pass.

BREAKING DOWN 'Stagflation'

Usually, when unemployment is high, spending declines, as do prices of goods. Stagflation occurs when the prices of goods rise while unemployment increases and spending declines. Stagflation can prove to be a particularly tough problem for governments to deal with due to the fact that most policies designed to lower inflation tend to make it tougher for the unemployed, and policies designed to ease unemployment raise inflation. 

This happened in the United States during the 1970s when world oil prices rose dramatically, increasing the costs of goods and contributing to a increase in unemployment. The following  stagnation increased the inflationary effects on the economy. Since the crisis in the 1970s, there has been little consensus on what exactly caused the economic problem. Each school of economics offers their own understanding on what exactly went wrong and why. 

Theories on the Causes of Stagflation

There are two main theories on what causes stagflation. One theory states that this economic phenomenon is caused when a sudden increase in the cost of oil reduces an economy's productive capacity. Because transportation costs rise, producing products and getting them to shelves gets more expensive and prices rise even as people get laid off. 

Another theory is that the confluence of stagnation and inflation are results of poorly made economic policy. Simply allowing inflation to go rampant, and then suddenly snapping the reigns on inflation is one example of poor policy that some have argued can contribute to stagflation, while others cite harsh regulation of markets, goods, and labor combined with allowing central banks to print excessive amounts of money are cited as another possible cause of stagflation. 

Jane Jacobs saw the inability of the major economic schools of thought to come to a conclusion on why stagflation occurred in the first place as a symptom of misplacing their scholarly focus on the nation as the primary economic engine as opposed to the city. It was her belief that in order to avoid the phenomenon of stagflation, that a country needed to provide an incentive to develop "import-replacing cities," that is, cities that balance import with production. This idea, essentially diversifying the economies of cities, was critiqued for it’s lack of scholarship by some, but held weight with others. 

Contemporary economists like Oliver Blanchard cite both supply shocks on the prices of goods and worker output, as well as incorrect predictions made by Keynesian economics as the cause of stagflation and the inability of economics to understand it.

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