What is Stagflation?

What is stagflation? A concept that many have a hard time understanding is stagflation. For the purposes of defining it, just consider that the word is a combination of stagnation and inflation.

In terms of the economy, stagflation is said to be occurring when the inflation rate is high with a slowing economy and high unemployment. Thus, inflation with a stagnant economy (sometimes even as bad as a recession).

The term itself is believed to date back to 1965. It was then used by British politician Iain Macleod who coined the term in a speech to Parliament.

It is not too surprising that stagflation is a difficult concept to comprehend. The Keynesian macroeconomic theory (popular in the decades following World War II) considered inflation and recession to be mutually exclusive meaning you could not have one when the other was occurring. However, history has proven this to be incorrect.

Modern economists theorize that stagflation can be caused by one of two factors. The first is a disruption in the supply chain resulting in higher prices and lower production. For example, flooding in Thailand in 2011 severely disrupted the computer hard drive market as many factories were destroyed. Consequently, the cost of available hard drives increased significantly with many less drives available in the market.

Macroenomic policies are also blamed for creating stagflation. Inflation can be created with monetary policies allowing too much currency into the market. However, fiscal policies such as over-regulation of industry can result in a stagnant economy. The two combined could spiral a country towards stagflation.

The power of stagflation also has far reaching consequences. It has even been known to influence Presidential elections as voters consider the effects of high inflation along with high unemployment.

The problem with stagflation is that it can be difficult to control once it starts occurring. For example, measures meant to combat inflation can increase unemployment with the vice versa also possible.

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