What is Stagflation?

The effects of inflation on the economy are not hidden as it creates serious concerns not only amongst economic planners but also common men. Now, imagine a situation where the economy is facing inflation along with rising unemployment and stagnant economic growth. A situation like this in the economy is referred to as stagflation, which almost appears to be paradoxical. Still, over the years, there have been instances where even developed countries have faced stagflation.

In a nutshell, stagflation is a situation that arises when inflation surges. There is a deceleration in the economy and a persistently high level of unemployment. A situation like this is tough to handle because making efforts to reduce inflation might trigger unemployment.

Stagflation has two major components: inflation and unemployment. A simple way to understand stagflation is that it denotes a slow-growing economy where there is high unemployment paired with reduced wages. At the same time, to curb inflation, the price of goods and services is increasing, which again diminishes the consumer purchasing power, thus creating a situation that appears almost impossible to curb. 

Historical Instances of Stagflation

Although economists around the world thought that a situation like stagflation was almost impossible to occur, there have been a few instances where even developed countries faced stagflation.

For instance, during the 1970s, when The US was already facing inflation it had to also deal with a sudden and evident price hike in oil due to OPEC oil embargoes. Due to the rising price of oil the Federal Reserve, to stimulate economic growth, adopted monetary policies that, instead of curbing the situation, decelerated the economy and led to two recessions in the US during the 1970s. This period is often marked as one of the first where the world saw stagflation. 

Causes of Stagflation

Now that you have a fair understanding of what is stagflation, let’s understand what are the causes that lead to stagflation:

• Demand-Side Factors

  A simple rule of the economy is that when the demand for goods and services is decreasing, the economy is meant to take a hit. A situation like this is regarded as a demand-side shock that can lead to stagflation. This usually happens when investors or common men are worried about their finances and reluctant to invest.

• Supply-Side Factors

  Simply put, supply-side factors talk about situations when there is a scarce or unreasonable price hike for essential commodities in the market like oil. To curb a situation where commodities in the market become scarce, businesses often resort to hiking up the price of these commodities, thus leaving the economy in a supply-side shock.

• Government Policies

  Government policies are one of the most common reasons for stagflation. This is because policies that might appear good on paper may not be practical. The government trying to boost the economy by losing its pockets or resorting to stringent practices can lead to stagflation.

Effects of Stagflation on the Economy

Since stagflation denotes an economic situation when there is inflation along with stagnant economic growth and rising unemployment it is obvious that there are severe effects of stagflation on the economy.

Let’s take a look at some of the effects of stagflation:

• Stagnant Economy

  Stagflation is meant to impact economic growth as investors are no longer in a position to make investments in businesses. Unemployment and rising prices of goods and services cut down the consumer's purchasing power, thus making the economy stand still.

• Rising Unemployment

  Rising unemployment and stagflation are almost mutually inclusive. Let’s take a simple example where there is a demand shock in the economy. In a situation like this, businesses and companies are habituated to cutting down their employee base and freezing the hiring process.

• Volatile Market

  Since stagflation creates an uncertain market economic situation, the market is subjected to face volatility. During stagnation, the performance of stocks and other forms of securities also takes a huge hit.

• Ineffective Central Bank

  Know that although stagflation has occurred in the past, it is not a very common economic situation, and therefore central banks don’t have the right policies to deal with such a situation. Curbing inflation without triggering any other impacts of stagflation becomes a huge challenge.

Additional Read - Central Bank Of India Share Price

Stagflations Vs Inflation: Key Differences

To begin with, economists usually find it difficult to pinpoint where inflation becomes stagflation. However, one rule that you must know is that inflation can occur without stagflation but stagflation can not occur without inflation. 

Here’s a table of key differences between stagflation and inflation:

How to Mitigate Stagflation

Mitigating a situation like stagflation is not easy as it marks an economy that is crumbling from every side. Therefore, it is argued that a blend of various policies can help mitigate.

Policy implementation is usually seen as the first hope to mitigate stagflation. A blend of monetary and fiscal policies can help mitigate stagflation. Simply put, mitigating stagflation calls for the central bank to amend monetary policies like increasing interest rates to curb inflation and at the same time, the government can introduce fiscal policies like reducing taxes and altering public expenditures.

Additionally, policymakers can play their part in diminishing the chances of stagflation by reducing the economy's reliance on commodities like oil, which has been a significant contributor in triggering stagflation. Rather, policymakers can focus on investing in Treasury Inflation-Protected Securities (TIPS), reducing debts to balance out high interest rates and prioritising job retention.

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