Stagnation: Definition, How It Works, and Example

What Is Stagnation?

Stagnation is a prolonged period of little or no growth in an economy often highlighted by periods of high unemployment. A rate of growth of less than 2-3% annually as measured by gross domestic product (GDP) is considered stagnation.

Stagnation can occur on a macroeconomic scale or in specific industries or companies. Stagnation may be either a temporary condition, such as a growth recession, temporary economic shock, or part of an economy's long-term structural condition.

Key Takeaways

  • Stagnation is a condition of slow or flat growth in an economy.
  • Stagnation often involves substantial unemployment and under-employment, as well as an economy generally performing below its potential.
  • Periods of stagnation can be short-lived or long-lasting, resulting in various economic and social effects.

Understanding Stagnation

Stagnation occurs within an economy when total output is either declining, flat, or growing slowly. Persistent unemployment, flat job growth, no wage increases, and an absence of stock market booms or highs are evidence of stagnation. As economies cycle through periods of recession to growth or from growth to recession, they may experience a time of stagnation.

Cyclical Stagnation

Stagnation can occur as a temporary condition in the course of an economic cycle or business cycle as a recession is ending and recovery is beginning. During these periods, both monetary policies and fiscal policies may be implemented to avoid prolonged stagnation.

Economic Shocks

Specific events or economic shocks can induce periods of stagnation which may be short-lived or have lasting effects, depending on the specific events and the resilience of the economy.

War and famine can be external factors that cause stagnation. A sudden increase in oil prices or a fall in demand for a key export could also induce a period of stagnation for an economy.

Structural Stagnation

A stagnant economy can result from longer-term, structural conditions in a society. Mature economies are characterized by slower population growth, stable economic institutions, and slower growth rates. Classical economists refer to this type of stagnation as a stationary state, and Keynesian economists consider it common in an advanced economy.

Institutional factors, such as entrenched power among incumbent special interest groups who oppose competition and openness, can induce economic stagnation. Western Europe experienced this type of economic stagnation during the 1970s and 1980s, dubbed Eurosclerosis.

Stagnation can afflict underdeveloped or emerging economies where stagnation persists due to the lack of change in political or economic institutions or regions with policies that discourage economic growth.

Overcoming Stagnation

Governments commonly implement a monetary policy or fiscal policy that spurs economic growth using tools such as:

Increasing Government Spending

Government investment in infrastructure encourages new business projects in construction and materials and increases job creation. As wages increase, additional money flows into the economy raising demand for goods and services and increasing aggregate economic growth.

Decreasing Taxes and Regulation

By reducing taxes and regulations, businesses or small business owners retain more capital for investment and innovation, improving growth in various sectors of the economy.

Lowering Interest Rates

When a central bank lowers interest rates, saving money becomes less attractive. People are more likely to increase their spending or invest in new businesses.

Stagnation vs. Stagflation vs. Recession

As an economy cycles from growth to decline, or decline to growth, it may have periods of stagnation, stagflation, or recession.

  • Stagnation is a prolonged period of slow economic growth as measured by gross domestic product (GDP) and may be accompanied by high unemployment.
  • Stagflation is a slow economic cycle that includes high inflation as well as high unemployment.
  • A recession is a significant and prolonged downturn in economic activity usually measured by two consecutive quarters of negative gross domestic product (GDP).

Real-World Example of Stagnation

The Great Recession, which began in 2008, kicked off a long period of economic stagnation, followed by a slow expansion from 2009 until the COVID-19 pandemic in 2020. GDP growth averaged 2.3% during this time. During the aftermath and recovery of the Great Recession, the Federal Reserve's monetary policy included quantitative easing to help the United States spur the stalled economy.

What Is the Average GDP During Periods of Stagnation?

Stagnation is a period of slow growth in an economy, characterized by a GDP under 2% or 3%.

How Are Investors Affected by Stagnation?

During a period of stagnation, the stock market sees fewer gains, and stock, mutual fund, and ETF prices often hold steady or fall slightly during stagnation.

How Are Workers Affected by Stagnation?

Stagnation is evident with higher unemployment and falling wages, making it difficult for individual workers to compete for jobs and wages.

The Bottom Line

Stagnation is a period of little or no growth in an economy characterized by a growth of less than 2-3% annually as measured by gross domestic product (GDP). Stagnation can be caused by business cycles, shocks to the economy, or the economic structure of a region. Governments commonly used both monetary and fiscal policies to reduce periods of prolonged stagnation.

Article Sources
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  1. Center on Budget and Policy Priorities. "Chart Book: Tracking the Post-Great Recession Economy."