Definition of Stagflation.
Stagflation is a period of rising inflation and falling output. With falling output, unemployment will tend to be rising.
Stagflation is often caused by a supply side shock. For example, rising commodity prices, such as oil prices, will cause a rise in business costs and Aggregate Supply will shift to the left. This causes a higher inflation rate and lower GDP.
People may talk about stagflation if there is a rise in inflation and a fall in the growth rate. This is less damaging than higher inflation and negative growth. But, it still represents a deterioration in the trade off between unemployment and inflation.
Stagflation and Phillips Curve
The traditional phillips curve suggests there is a trade off between inflation and unemployment. A period of stagflation will shift the Phillips curve to the right, giving a worse trade off.
Stagflation in the 1970s
In 1974, we have an inflation spike of 25%, at the same time, we see negative GDP growth. This was caused by the oil price boom and also end of the Barber Boom.
Staglation in 2011
In 2011, the UK experienced a rise in inflation to 5%, at the same time, we experienced economic stagnation, with a very low growth rate.
This was caused by:
- Higher oil prices
- Higher food prices
- Impact of devaluation increasing import prices
- Impact of higher taxes, which increased inflation but reduced living standards.
- see also: cost push inflation
Solutions to Stagflation
There are no easy solutions to stagflation, though supply side policies to increase productivity may help. Solutions to Stagflation