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Stagflation



Definition

Stagflation is a complex economic scenario characterized by slow economic growth (stagnation) and high unemployment, coupled with high inflation. These conditions typically shouldn’t occur together as per traditional economic theory. It is a difficult condition to manage as actions to reduce inflation might exacerbate unemployment, and vice versa.

Phonetic

The phonetic spelling of the word “Stagflation” is: /stæɡˈfleɪʃən/

Key Takeaways

  1. Definition: Stagflation is a combination of stagnant economic growth, high unemployment, and high inflation. It’s an unusual situation because inflation typically doesn’t occur in a stagnant economy.
  2. Causes: Stagflation can be triggered by a supply shock that results in a sudden increase in the price of goods and resources, reducing the supply of goods across various sectors of the economy. This could disrupt the balance between supply and demand, leading to price increases (inflation) and economic stagnation.
  3. Effects: Stagflation can be a major challenge for policymakers: traditional methods of dealing with high inflation (tightening monetary policy) may exacerbate unemployment and further stagnate growth. Similarly, methods to boost growth or reduce unemployment (like looser fiscal policy) could in turn lead to even higher inflation. Therefore, managing stagflation requires very careful and balanced economic policy.

Importance

Stagflation is an important term in business and finance because it represents an unfavorable economic situation characterized by a stagnant economy, high inflation, and high unemployment. In such a condition, the inflation rate is high, the economic growth rate is slow, and unemployment remains steadily high. This scenario is challenging for businesses because it erodes purchasing power, making products and services more expensive, which can cut into profits. Additionally, the high unemployment rates reduce consumer spending, negatively impacting businesses’ revenue streams. Economists and policymakers also fear stagflation because it is difficult to manage with traditional monetary policies and could lead to long-term economic and fiscal harm. This makes understanding and addressing stagflation paramount to the stability and health of the economy.

Explanation

Stagflation is an economic circumstance that is usually not the target of economic policies, but is often a reality faced by countries. Stagflation refers to a situation in the economy where inflation and unemployment rates are high while growth rate of the economy remains stagnant. This condition usually arises when an economy faces supply shocks and is widely regarded as problematic because it puts policymakers in a bind as managing inflation and unemployment separately is significantly easier.Stagflation helps in shaping monetary and fiscal policies of an economy when in a supply shock crisis. It is an indicator of a stagnated economy which needs strategic interventions to correct the conditions of high unemployment and inflation. It thereby assists in identifying the changes that are necessary for bringing the economy back to balance. Economists and policy makers study the signals of stagflation to avoid getting into a trap of this harmful economic condition. Infact, bringing an economy out from stagflation requires careful economic planning, monetary policies, and in certain circumstances, can even lead to the need for structural changes in the economy.

Examples

1. United States in the 1970s: This period is perhaps the most often cited example of stagflation. It was triggered by several events including the quadrupling of oil prices in 1973 and the doubling again in 1979. During this time, U.S. experienced inflation rates as high as 12% coupled with high unemployment rates. The country’s GDP growth rate was also lackluster, emphasizing the stagnation aspect of the economic condition.2. Japan in the 1990s: Also known as “the lost decade,” Japan saw its economy stuck in a rut for several years. The bursting of the bubble economy in the early 1990s led to a prolonged period of stagnant growth and price deflation. Then, in the mid to late 1990s, the situation transformed into stagflation as Japan was hit by a financial crisis that led to inflation without any corresponding growth in the economy.3. Zimbabwe in the late 2000s: The country suffered a severe case of stagflation. Mismanagement of monetary policy led to Zimbabwe suffering from hyperinflation, where rates exceeded 89 sextillion percent per month in November 2008. Despite this extreme rate of inflation, the GDP of the country was shrinking, leading to further unemployment and economic stagnation.

Frequently Asked Questions(FAQ)

What is stagflation?

Stagflation is an unusual economic situation in which high inflation (rising prices) and high unemployment coexist with slow or declining growth in the gross domestic product (GDP).

What causes stagflation?

Stagflation is typically caused by a significant drop in supply due to events like increased production costs, natural disasters, or increased regulation and restrictions, all of which can lead to increased prices. Simultaneously, demand stays the same or decreases, leading to unemployment and stagnant economic growth.

How can stagflation be combated?

It’s challenging to combat stagflation because standard economic policies aren’t generally effective against it. Increasing interest rates can fight inflation but may increase unemployment, whereas decreasing interest rates might decrease unemployment but increase inflation. A balanced approach, along with an emphasis on increasing the overall productivity, is typically needed to combat stagflation.

Is stagflation common?

Stagflation is relatively rare because inflation and unemployment don’t typically increase at the same time. It mostly happened in developed economies in the 1970s due to oil price shocks and poor monetary policies.

Can stagflation have long-term impacts on the economy?

Yes, prolonged stagflation can lead to prolonged periods of lower living standards and increased social discontent. It can also lead to reduced investor confidence and lowered economic growth potential.

How can a business protect itself from stagflation?

Businesses can protect themselves from stagflation by maintaining a diverse portfolio, focusing on cost efficiency, and creating goods and services that remain in demand even during difficult economic times.

How does stagflation affect the stock market?

Stagflation tends to cause uncertainty in the stock market. It can lead to decreased investor confidence, causing market volatility and potentially falling stock prices. Some sectors, like consumer staples and utilities, may perform better during stagflation because their demand remains consistent regardless of economic conditions.

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