Explained: What is stagflation?
Let's understand the concept of Stagflation.
Investors, bankers, and entrepreneurs have been discussing the chances of an upcoming recession. Now, World Bank is also joining their chorus that a recession is likely to take place. President of World Bank - David Malpass said that most countries are headed towards a recession and warns of a possible return to 1970s ‘stagflation’.
A question pops up here, what is stagflation? In simple words, inflation plus stagnant growth equals stagflation. It can be defined as a period of inflation combined with a decline in the gross domestic product (GDP). It is characterised by slow economic growth and high unemployment.
Generally, the strong bargaining power of trade unions, falling productivity, disruption to supply chains, and a rise in structural unemployment are the main causes of stagflation.
What happened in the 1970s?
Stagflation was first recognised during the 1970s when many developed economies experienced rapid inflation and high unemployment. One theory states that stagflation is caused when a sudden rise in oil prices reduces an economy's productive capacity. In 1973, Organisation of Petroleum Exporting Countries (OPEC) issued a ban against western countries. This decision led to a dramatic rise in the global oil prices, which ultimately, resulted in an increase in the cost of goods and a rise in unemployment.
Why is it bad?
Slow economic growth may lead to an increase in unemployment but it should not result in rising prices. This is contradictory and that’s why it is considered bad for the economy. An increase in the unemployment level results in a decrease in consumer spending power, which affects the country’s demand-supply levels.
Can it be resolved?
As per the economists, an increase in productivity up to the point where it would lead to higher growth without additional inflation is the best cure for stagflation. Another solution to stagflation is to increase aggregate supply (AS) through supply-side policies.