Stagflation - Wikipedia, the free encyclopedia http://en.wikipedia.org/wiki/Stagflation Stagflation From Wikipedia, the free encyclopedia In economics, stagflation is a situation in which the inflation rate is high, the economic growth rate slows down, and unemployment remains Economics steadily high. It raises a dilemma for economic policy since actions designed to lower inflation or reduce unemployment may actually worsen economic growth. The portmanteau stagflation is generally attributed to British politician Iain Macleod, who coined the phrase in his speech to Parliament in 1965. [1][2][3] [4] Economies by region The concept is notable because, in the version of Keynesian Africa · North America macroeconomic theory which was dominant between the end of WWII South America · Asia and the late-1970s, inflation and recession were regarded as mutually Europe · Oceania exclusive, the relationship between the two being described by the Phillips curve. Stagflation is also notable because it has generally proven General categories to be difficult and, in human terms as well as budget deficits, very costly Microeconomics · Macroeconomics to eradicate once it starts. History of economic thought Methodology · Heterodox approaches In the political arena, one measure of stagflation, termed the Misery Technical methods Index (derived by the simple addition of the inflation rate to the Mathematical · Econometrics unemployment rate), was used to swing presidential elections in the United States in 1976 and 1980. Experimental · National accounting Fields and subfields Behavioral · Cultural · Evolutionary Growth · Development · History Contents International · Economic systems Monetary and Financial economics 1 Causes Public and Welfare economics 2 Postwar Keynesian and monetarist views Health · Education · Welfare 2.1 Early Keynesianism and monetarism Population · Labour · Personnel 2.2 Neo-Keynesianism Managerial · Computational 2.3 Supply theory Business · Information · Game theory 2.3.1 Fundamentals Industrial organization · Law Agricultural · Natural resource 2.3.2 Explaining the 1970s stagflation Environmental · Ecological 2.3.3 Theoretical responses Urban · Rural · Regional · Geography 3 Recent views 4 Neoclassical views Lists 4.1 Keynesian in the short run, classical in the long run 5 Alternative views Journals · Publications 5.1 As differential accumulation Categories · Topics · Economists 5.2 Demand-pull stagflation theory The economy: concept and history 5.3 Supply-side theory Business and Economics Portal 5.4 Austrian School of economics 6 Responses 7 See also 8 Notes 9 References Causes 1 of 8 7/06/2012 2:38 AM Stagflation - Wikipedia, the free encyclopedia http://en.wikipedia.org/wiki/Stagflation Economists offer two principal explanations for why stagflation occurs. First, stagflation can result when the productive capacity of an economy is reduced by an unfavorable supply shock, such as an increase in the price of oil for an oil importing country. Such an unfavorable supply shock tends to raise prices at the same time that it slows the economy by making production more costly and less profitable. [5][6][7] Second, both stagnation and inflation can result from inappropriate macroeconomic policies. For example, central banks can cause inflation by permitting excessive growth of the money supply,[8] and the government can cause stagnation by excessive regulation of goods markets and labor markets. [9] Either of these factors can cause stagflation. Excessive growth of the money supply taken to such an extreme that it must be reversed abruptly can clearly be a cause. Both types of explanations are offered in analyses of the global stagflation of the 1970s: it began with a huge rise in oil prices, but then continued as central banks used excessively stimulative monetary policy to counteract the resulting recession, causing a runaway wage-price spiral.[10] Postwar Keynesian and monetarist views Early Keynesianism and monetarism Up to the 1960s many Keynesian economists ignored the possibility of stagflation, because historical experience suggested that high unemployment was typically associated with low inflation, and vice versa (this relationship is called the Phillips curve ). The idea was that high demand for goods drives up prices, and also encourages firms to hire more; and likewise high employment raises demand. However, in the 1970s and 1980s, when stagflation occurred, it became obvious that the relationship between inflation and employment levels was not necessarily stable: that is, the Phillips relationship could shift. Macroeconomists became more skeptical of Keynesian theories, and the Keynesians themselves reconsidered their ideas in search of an explanation of stagflation. [11] The explanation for the shift of the Phillips curve was initially provided by the monetarist economist Milton Friedman, and also by Edmund Phelps. Both argued that when workers and firms begin to expect more inflation, the Phillips curve shifts up (meaning that more inflation occurs at any given level of unemployment). In particular, they suggested that if inflation lasted for several years, workers and firms would start to take it into account during wage negotiations, causing workers' wages and firms' costs to rise more quickly, thus further increasing inflation. While this idea was a severe criticism of early Keynesian theories, it was gradually accepted by most Keynesians, and has been incorporated into New Keynesian economic models. Neo-Keynesianism Contemporary Keynesian analyses argue that stagflation can be understood by distinguishing factors that affect aggregate demand from those that affect aggregate supply. While monetary and fiscal policy can be used to stabilize the economy in the face of aggregate demand fluctuations, they are not very useful in confronting aggregate supply fluctuations. In particular, an adverse shock to aggregate supply, such as an increase in oil prices, can give rise to stagflation. [12] Neo-Keynesian theory distinguished two distinct kinds of inflation: demand-pull (caus ed by shifts of the aggregate demand curve) and cost-push (caused by shifts of the aggregate supply curve). Stagflation, in this view, is caused by cost-push inflation. Cost-push inflation occurs when some force or condition increases the costs of production. This could be caused by government policies (such as taxes), or from purely external factors such as a shortage of natural resources or an act of war. Supply theory 2 of 8 7/06/2012 2:38 AM Stagflation - Wikipedia, the free encyclopedia http://en.wikipedia.org/wiki/Stagflation Fundamentals Supply theories [13] are based on the neo-Keynesian cost-push model and attribute stagflation to significant disruptions to the supply side of the supply-demand market equation, for example, when there is a sudden real or relative scarcity of key commodities, natural resources, or natural capital needed to produce goods and services. Other factors may also cause supply problems, for example, social and political conditions such as policy changes, acts of war, extremely restrictive government control of production (For example monopolizing Dictatorships). [citation needed ] In this view, stagflation is thought to occur when there is an adverse supply shock (for example, a sudden increase in the price of oil or a new tax) that causes a subsequent jump in the "cost" of goods and services (often at the wholesale level). In technical terms, this results in contraction or negative shift in an economy's aggregate supply curve.[citation needed ] In the resource scarcity scenario (Zinam 1982), stagflation results when economic growth is inhibited by a restricted supply of raw materials. [14][15] That is, when the actual or relative supply of basic materials (fossil fuels (energy), minerals, agricultural land in production, timber, etc.) decreases and/or cannot be increased fast enough in response to rising or continuing demand. The resource shortage may be a real physical shortage or a relative scarcity due to factors such as taxes or bad monetary policy which have affected the "cost" or availability of raw materials. This is consistent with the cost-push inflation factors in neo-Keynesian theory (above). The way this plays out is that after supply shock occurs, the economy will first try to maintain momentum — that is, consumers and businesses will begin paying higher prices in order to maintain their level of demand. The central bank may exacerbate this by increasing the money supply, by lowering interest rates for example, in an effort to combat a recession. The increased money supply props up the demand for goods and services, though demand would normally drop during a recession. [citation needed ] In the Keynesian model, higher prices will prompt increases in the supply of goods and services. However, during a supply shock (i.e. scarcity, "bottleneck" in resources, etc.), supplies don't respond as they normally would to these price pressures. So, inflation jumps and output drops, producing stagflation. [citation needed ] Explaining the 1970s stagflation Further information: Nixon Shock Following Richard Nixon's imposition of wage and price controls on August 15, 1971, an initial wave of cost-push shocks in commodities was blamed for causing spiraling prices. Perhaps the most notorious factor cited at that time was the failure of the Peruvian anchovy fishery in 1972, a major source of livestock feed. [16] The second major shock was the 1973 oil crisis, when the Organization of Petroleum Exporting