What is stagflation?

Stagflation is characterized by slow economic growth and relatively high unemployment—or economic stagnation—which is at the same time accompanied by rising prices (i.e. inflation). Stagflation can be alternatively defined as a period of inflation combined with a decline in gross domestic product (GDP).

The term "stagflation" was first used in the 1960s during a time of economic stress in the United Kingdom by politician Iain Macleod while he was speaking in the House of Commons. Talking about inflation on one side and stagnation on the other, he called it a "stagnation situation." It was later used again to describe the recessionary period in the 1970s following the oil crisis, when the U.S. underwent a recession that saw five quarters of negative GDP growth.1

 Inflation doubled in 1973 and hit double digits in 1974; unemployment hit 9% by May 1975.23

Stagflation led to the emergence of the misery index. This index, which is the simple sum of the inflation rate and unemployment rate, served as a tool to show just how badly people were feeling when stagflation hit the economy.

Stagflation was long believed to be impossible because the economic theories that dominated academic and policy circles ruled it out of their models by construction. In particular, the economic theory of the Phillips Curve, which developed in the context of Keynesian economics, portrayed macroeconomic policy as a trade-off between unemployment and inflation. As a result of the Great Depression and the ascendance of Keynesian economics in the 20th century, economists became preoccupied with the dangers of deflation and argued that most policies designed to lower inflation tend to make it tougher for the unemployed, and policies designed to ease unemployment raise inflation.

The advent of stagflation across the developed world in the mid-20th century showed that this was actually not the case. As a result, stagflation is a great example of how real-world economic data can sometimes run roughshod over widely accepted economic theories and policy prescriptions.

investopedia