Stagflation definition

The generally agreed-upon stagflation definition is a state of the economy that exhibits elevated unemployment rates and inflation at the same time. Typically, stagflation presents serious problems for monetary policymakers, since the remedies for high unemployment are nearly directly opposed to the remedies available for inflationary cycles.  Most economists believe stagflation can be attributed to either failed economic policies or to destructive or catastrophic events that seriously affect the production capability of the overall economy. During the 1970s, for instance, the United States experienced a prolonged period of stagflation due primarily to shortages of raw materials.  Livestock feed manufacturing was significantly impacted by the loss of the Peruvian anchovy fishery in 1972, but the most significant economic factor was likely the oil crisis of 1973, when OPEC severely limited the international oil supply in order to control prices and boost profits for their members.

Negative effects of stagflation

Regardless of its origins, stagflation is likely to cause significant and prolonged economic problems that cannot be easily resolved. High unemployment reduces the overall buying power of consumers and companies, and increasing prices lessen that buying power even more. This can put a financial squeeze on both the consumer and the corporate sector and cause still more unemployment as companies try to compensate for lower profits, increasing expenses and the resulting reduction in financial liquidity.

Stagflation vs. hyperinflation

Stagflation is sometimes confused with hyperinflation; while the two economic situations do share certain aspects in common, there are significant differences in stagflation vs. hyperinflation. While stagflation typically arises in response to a lack of raw materials, hyperinflation is nearly always the result of mismanaged economic policy. Specifically, hyperinflation is a response to the government printing large money in order to meet its obligations. When large amounts of money flood the economy in a short amount of time, this reduces the value of all money in the economy and reduces the incentive for consumers to save. This, in turn, affects the amount of money available for loans and pushes the interest rate for those loans upward, causing the economy to contract and the overall worth of money to decline. Hyperinflation is generally addressed by a gradual reduction in the amount of printed money and conservative monetary policies over a period of years. Stagflation is a more complex situation that cannot be resolved by reducing the supply of printed money, since this solution addresses only the inflationary portion of the problem and may worsen the unemployment situation.

Difficulties in addressing stagflation

Because stagflation is a combination of high unemployment and inflation, the remedies available for one of these conditions typically make the other worse. For instance, monetary policy adjustments that are intended to curb inflation typically create higher unemployment, while government spending to reduce unemployment usually worsens inflationary spirals. Macroeconomic solutions to stagflation generally result in limited improvement at best and may even make the situation significantly worse due to the simultaneous presence of these two inverse economic effects. Generally, the only viable solution for stagflation is to boost the production capability of the economy by restoring the supply of raw materials or creating new economic streams that take advantage of materials that are still readily available. This process usually takes time and investment on the part of economic policymakers, and cannot be instituted overnight or without careful planning and preparation.
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