Understanding Stagflation

Stagflation is an economic cycle characterized by slow growth and a high unemployment rate accompanied by inflation. Economic policymakers find this combination particularly difficult to handle, as attempting to correct one of the factors can exacerbate another.

Once thought by economists to be impossible, stagflation has occurred repeatedly in the developed world since the 1970s oil crisis.

In mid-2022, many were saying that the United States had not entered a period of stagflation, but might soon experience one, at least for a short period. In June 2022, Forbes magazine argued that a period of stagflation was likely because economic policymakers would tackle unemployment first, leaving inflation to be dealt with later.

Stagflation is the simultaneous appearance in an economy of slow growth, high unemployment, and rising prices.

Once thought by economists to be impossible, stagflation has occurred repeatedly in the developed world since the 1970s. Policy solutions for slow growth tend to worsen inflation, and vice versa. That makes stagflation hard to fight.

The term stagflation was first used by British politician Iain Macleod in a speech before the House of Commons in 1965, a time of economic stress in the United Kingdom.

He called the combined effects of inflation and stagnation a “’stagflation situation.”

The term was revived in the U.S. during the 1970s oil crisis, which caused a recession that included five consecutive quarters of negative GDP growth.

Inflation doubled in 1973 and hit double digits in 1974. Unemployment reached 9% by May 1975.

The effects of stagflation were illustrated by means of a misery index. This index, a simple sum of the inflation rate and the unemployment rate, tracked the real-world effects of stagflation on a nation’s people. Stagflation was once believed to be impossible. The economic theories that dominated academic and policy circles for much of the 20th century ruled it out of their models. 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, economists became preoccupied with the dangers of deflation and argued that most policies designed to lower inflation tend to increase unemployment, while policies designed to lower unemployment raise inflation.

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