A:

Stagflation is most commonly referred to as the simultaneous experience of three separate negative economic phenomena: rising inflation, rising unemployment and a declining demand for goods and services. Despite several examples of stagflating Western economies during the 19th and 20th centuries, many economists did not believe that stagflation could exist because of the Phillips curve, which viewed inflation and recession as diametrically opposite forces.

The term "stagflation" was made popular in 1965 by a member of the British Parliament, Iain Macleod, who told the House of Commons that the U.K. economy had "the worst of both worlds," meaning stagnation and inflation. He referred to it as "a sort of 'stagflation' situation." However, stagflation wouldn't gain worldwide renown until the mid- to late 1970s, when more than half a dozen major economies went through a period of rising prices and unemployment.

Inflation, Unemployment and Recession

Inflation refers to an increase in the supply of money (money stock) that causes the general level of prices in the economy to go up. When more units of money are available to chase the same number of goods, the laws of supply and demand dictate that each individual money unit becomes less valuable.

Not every rise in prices is considered inflation. Prices can rise because consumers demand more goods or because resources become scarcer. Indeed, prices frequently rise and fall for individual commodities. When prices rise as a result of an over-abundance of money stock, it is called inflation.

Unemployment refers to the percentage of the workforce that would like to find a job but is unable to. Economists often differentiate between seasonal or frictional unemployment, which occurs as a natural part of market processes, and structural unemployment (sometimes called institutional unemployment). Structural unemployment is more controversial; some believe that governments must intervene to solve structural unemployment while others believe that government intervention is its root cause.

Recession is commonly defined as two consecutive quarters of negative economic growth as measured by gross domestic product (GDP). It is also known as economic contraction. The National Bureau of Economic Research (NBER) states that recession is "a period of diminishing activity rather than diminished activity." Typically, recessions are characterized by falling demand for existing goods and services, declining real wages, temporary increases in unemployment and an increase in savings.

Explanation of Stagflation

Contemporary monetary or fiscal policy is ill-equipped to handle a period of stagflation. The policy tools prescribed by macroeconomics to combat rising inflation include reduced government spending, increased taxes, rising interest rates and a raising of bank reserve requirements. The remedy for rising unemployment is exactly the opposite: more spending, less taxes, lower interest rates and encouraging banks to lend.

According to Edmund Phelps and Milton Friedman, the Keynesians were wrong to assume that there was a real long-run trade-off between inflation and unemployment. They suggested that loose central bank policies would eventually lead to lower real economic growth and a higher long-run inflation rate.

Other economists contend that demand is limited by production, which serves as a means of securing goods and services. Therefore, any monetary stimulus that dilutes the real wealth created by wealth generators – businesses and entrepreneurs -- and weakens their ability to grow the economy through gains in productivity. The result is a messy recession with dropping output and rising prices.

RELATED FAQS
  1. What Actions Can Be Used to Control Stagflation?

    Find out why economic stagflation cannot be corrected through traditional fiscal or monetary policy and why it was thought ... Read Answer >>
  2. What is the difference between inflation and stagflation?

    Inflation is a term used by economists to define broad increases in prices. Inflation is the rate at which the price of goods ... Read Answer >>
  3. What's the difference between cyclical unemployment and seasonal unemployment?

    Learn about the key differences between cyclical and seasonal unemployment. Read about distinguishing features of each of ... Read Answer >>
  4. What are some examples of expansionary monetary policy?

    Learn about expansionary monetary policy and how central banks use discount rates, reserve ratios and purchases of securities ... Read Answer >>
Related Articles
  1. Insights

    Stagflation, 1970s Style

    Find out how Milton Friedman's monetarist theory helped bring the U.S. out of the economic doldrums.
  2. Insights

    The Downside of Low Unemployment

    Yes, the unemployment rate can be too low.
  3. Insights

    A Review Of Past Recessions

    Here we look at the biggest economic declines in the U.S. since the Great Depression.
  4. Insights

    Famous Short-Seller Predicts Wave of "Stagflation" to Come

    Kyle Bass, who bet against subprime mortgages before the financial crisis of 2008, has made dire predictions for the U.S. economy in the year to come.
  5. Insights

    A Primer On Inflation

    Inflation has a negative connotation, but is it all bad or does it offer some tangible benefits?
  6. Insights

    Monetarism: Printing Money To Curb Inflation

    Learn how Milton Friedman's monetarist views shaped economic policy after World War II.
  7. Insights

    Recessions and Depressions Aren't So Bad

    Downturns like depressions and recessions are a natural part of the economic cycle and can actually provide some benefits.
RELATED TERMS
  1. Stagflation

    Stagflation is the combination of slow economic growth and high ...
  2. Full Employment

    Full employment is a situation in which all available labor resources ...
  3. Unemployment Insurance

    Unemployment insurance is a benefit for workers who meet eligibility ...
  4. Hysteresis

    In economics, hysteresis refers to an event in the economy that ...
  5. Economic Recovery

    An economic recovery is a period of increasing business activity ...
  6. GDP Gap

    GDP gap is the forfeited output of a country's economy resulting ...
Hot Definitions
  1. Risk Tolerance

    Risk tolerance is the degree of variability in investment returns that an individual is willing to withstand.
  2. Initial Coin Offering (ICO)

    An Initial Coin Offering (ICO) is an unregulated means by which funds are raised for a new cryptocurrency venture.
  3. Federal Funds Rate

    The federal funds rate is the interest rate at which a depository institution lends funds maintained at the Federal Reserve ...
  4. Ethereum

    Ethereum is a decentralized software platform that enables SmartContracts and Distributed Applications (ĐApps) to be built ...
  5. Perfect Competition

    Pure or perfect competition is a theoretical market structure in which a number of criteria such as perfect information and ...
  6. Restricted Stock Unit - RSU

    A restricted stock unit is a compensation issued by an employer to an employee in the form of company stock.
Trading Center