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In economics, stagflation, or recession-inflation, is a situation in which the inflation rate is high, the economic growth rate slows, and
unemployment remains steadily high. It presents a dilemma for economic policy, since actions intended to lower inflation may exacerbate
unemployment, and vice versa.

The term, a portmanteau of stagnation and inflation, is generally attributed to Iain Macleod, a British Conservative Party politician who became
Chancellor of the Exchequer in 1970. Macleod used the word in a 1965 speech to Parliament during a period of simultaneously high inflation
and unemployment in the United Kingdom.[1][2][3][4]

Warning the House of Commons of the gravity of the situation, he said:

"We now have the worst of both worlds—not just inflation on the one side or stagnation on the other, but both of them
together. We have a sort of "stagflation" situation. And history, in modern terms, is indeed being made."[3][5]

Macleod used the term again on 7 July 1970, and the media began also to use it, for example in The Economist on 15 August 1970, and
Newsweek on 19 March 1973.

John Maynard Keynes did not use the term, but some of his work refers to the conditions that most would recognise as stagflation. In the
version of Keynesian macroeconomic theory that was dominant between the end of World War II and the late 1970s, inflation and recession
were regarded as mutually exclusive, the relationship between the two being described by the Phillips curve. Stagflation is very costly and
difficult to eradicate once it starts, both in social terms and in budget deficits.

The Great Inflation

The term stagflation, a portmanteau of stagnation and inflation, was first coined during a period of inflation and unemployment in the United
Kingdom. The United Kingdom experienced an outbreak of inflation in the 1960s and 1970s. On 17 November 1965, Iain Macleod, the
spokesman on economic issues for the United Kingdom's Conservative Party, [finish]

In a Bank of England working papers series, article authors Edward Nelson and Kalin Nikolov (2002) examined causes and policy errors related
to the Great Inflation in the United Kingdom in the 1970s, arguing that as inflation rose in the 1960s and 1970s, UK policy makers failed to
recognize the primary role of monetary policy in controlling inflation. Instead, they attempted to use non-monetary policies and devices to
respond to the economic crisis. Policy makers also made "inaccurate estimates of the degree of excess demand in the economy, [which]
contributed significantly to the outbreak of inflation in the United Kingdom in the 1960s and 1970s.[3]

Stagflation was not limited to the United Kingdom, however. Economists have shown that stagflation was prevalent among seven major
economies from 1973 to 1982.[6] After inflation rates began to fall in 1982, economists' focus shifted from the causes of stagflation to the
"determinants of productivity growth and the effects of real wages on the demand for labor."[6]

Causes

Economists offer two principal explanations for why stagflation occurs. First, stagflation can result when the economy faces a supply shock, such
as a rapid increase in the price of oil. An unfavorable situation like that tends to raise prices at the same time as it slows economic growth by
making production more costly and less profitable.[7][8][9][10]

Second, the government can cause stagflation if it creates policies that harm industry while growing the money supply too quickly. These two
things would probably have to occur simultaneously because policies that slow economic growth do not usually cause inflation, and policies
that cause inflation do not usually slow economic growth.

Both 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 price/wage spiral.[11]

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

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necessarily stable: that is, the Phillips relationship could shift. Macroeconomists became more skeptical of Keynesian theories, and Keynesians
themselves reconsidered their ideas in search of an explanation for stagflation.[12]

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

Neo-Keynesian theory distinguished two distinct kinds of inflation: demand-pull (caused 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.

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 stabilise 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.[13]

Supply theory

Fundamentals

Supply theories[14] 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. 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.

In the resource scarcity scenario (Zinam 1982), stagflation results when economic growth is inhibited by a restricted supply of raw
materials.[15][16] 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 influencing 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 first tries to maintain momentum. That is, consumers and businesses begin paying higher prices 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.

In the Keynesian model, higher prices prompt increases in the supply of goods and services. However, during a supply shock (i.e., scarcity,
"bottleneck" in resources, etc.), supplies do not respond as they normally would to these price pressures. So, inflation jumps and output drops,
producing stagflation.

Explaining the 1970s stagflation

Further information: Nixon Shock

Following Richard Nixon's imposition of wage and price controls on 15 August 1971, an initial wave of cost-push shocks in commodities were
blamed for causing spiraling prices. The second major shock was the 1973 oil crisis, when the Organization of Petroleum Exporting Countries
(OPEC) constrained the worldwide supply of oil.[17] Both events, combined with the overall energy shortage that characterized the 1970s,
resulted in actual or relative scarcity of raw materials. The price controls resulted in shortages at the point of purchase, causing, for example,
queues of consumers at fuelling stations and increased production costs for industry.[18]

Recent views

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Through the mid-1970s, it was alleged that none of the major macroeconomic models (Keynesian, New Classical, and monetarist) were able to
explain stagflation.[19]

Later, an explanation was provided based on the effects of adverse supply shocks on both inflation and output.[20] According to Blanchard
(2009), these adverse events were one of two components of stagflation; the other was "ideas"—which Robert Lucas (famous for the Lucas
supply curve), Thomas Sargent, and Robert Barro were cited as expressing as "wildly incorrect" and "fundamentally flawed" predictions (of
Keynesian economics) which, they said, left stagflation to be explained by "contemporary students of the business cycle."[21] In this discussion,
Blanchard hypothesizes that the recent oil price increases could trigger another period of stagflation, although this has not yet happened (pg.
152).

Neoclassical views

A purely neoclassical view of the macroeconomy rejects the idea that monetary policy can have real effects.[22] Neoclassical macroeconomists
argue that real economic quantities, like real output, employment, and unemployment, are determined by real factors only. Nominal factors like
changes in the money supply only affect nominal variables like inflation. The neoclassical idea that nominal factors cannot have real effects is
often called monetary neutrality[23] or also the classical dichotomy.

Since the neoclassical viewpoint says that real phenomena like unemployment are essentially unrelated to nominal phenomena like inflation, a
neoclassical economist would offer two separate explanations for 'stagnation' and 'inflation'. Neoclassical explanations of stagnation (low
growth and high unemployment) include inefficient government regulations or high benefits for the unemployed that give people less incentive
to look for jobs. Another neoclassical explanation of stagnation is given by real business cycle theory, in which any decrease in labour
productivity makes it efficient to work less. The main neoclassical explanation of inflation is very simple: it happens when the monetary
authorities increase the money supply too much.[24]

In the neoclassical viewpoint, the real factors that determine output and unemployment affect the aggregate supply curve only. The nominal
factors that determine inflation affect the aggregate demand curve only.[25] When some adverse changes in real factors are shifting the
aggregate supply curve left at the same time that unwise monetary policies are shifting the aggregate demand curve right, the result is
stagflation.

Thus the main explanation for stagflation under a classical view of the economy is simply policy errors that affect both inflation and the labour
market. Ironically, a very clear argument in favour of the classical explanation of stagflation was provided by Keynes himself. In 1919, John
Maynard Keynes described the inflation and economic stagnation gripping Europe in his book The Economic Consequences of the Peace.
Keynes wrote:

"Lenin is said to have declared that the best way to destroy the Capitalist System was to debauch the currency. By a continuing process of
inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens. By this method they not only
confiscate, but they confiscate arbitrarily; and, while the process impoverishes many, it actually enriches some." [...]
"Lenin was certainly right. There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The
process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is
able to diagnose."

Keynes explicitly pointed out the relationship between governments printing money and inflation.

"The inflationism of the currency systems of Europe has proceeded to extraordinary lengths. The various belligerent Governments, unable, or
too timid or too short-sighted to secure from loans or taxes the resources they required, have printed notes for the balance."

Keynes also pointed out how government price controls discourage production.

"The presumption of a spurious value for the currency, by the force of law expressed in the regulation of prices, contains in itself, however,
the seeds of final economic decay, and soon dries up the sources of ultimate supply. If a man is compelled to exchange the fruits of his
labours for paper which, as experience soon teaches him, he cannot use to purchase what he requires at a price comparable to that which he
has received for his own products, he will keep his produce for himself, dispose of it to his friends and neighbours as a favour, or relax his
efforts in producing it. A system of compelling the exchange of commodities at what is not their real relative value not only relaxes
production, but leads finally to the waste and inefficiency of barter."

Keynes detailed the relationship between German government deficits and inflation.

"In Germany the total expenditure of the Empire, the Federal States, and the Communes in 1919–20 is estimated at 25 milliards of marks, of
which not above 10 milliards are covered by previously existing taxation. This is without allowing anything for the payment of the indemnity.
In Russia, Poland, Hungary, or Austria such a thing as a budget cannot be seriously considered to exist at all."
"Thus the menace of inflationism described above is not merely a product of the war, of which peace begins the cure. It is a continuing
phenomenon of which the end is not yet in sight."

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Keynesian in the short run, classical in the long run

While most economists believe that changes in money supply can have some real effects in the short run, neoclassical and neo-Keynesian
economists tend to agree that there are no long-run effects from changing the money supply. Therefore, even economists who consider
themselves neo-Keynesians usually believe that in the long run, money is neutral. In other words, while neoclassical and neo-Keynesian models
are often seen as competing points of view, they can also be seen as two descriptions appropriate for different time horizons. Many mainstream
textbooks today treat the neo-Keynesian model as a more appropriate description of the economy in the short run, when prices are 'sticky', and
treat the neoclassical model as a more appropriate description of the economy in the long run, when prices have sufficient time to adjust fully.

Therefore, while mainstream economists today might often attribute short periods of stagflation (not more than a few years) to adverse
changes in supply, they would not accept this as an explanation of very prolonged stagflation. More prolonged stagflation would be explained
as the effect of inappropriate government policies: excessive regulation of product markets and labor markets leading to long-run stagnation,
and excessive growth of the money supply leading to long-run inflation.

Alternative views

As differential accumulation
Main article: Differential accumulation

Political economists Jonathan Nitzan and Shimshon Bichler have proposed an explanation of stagflation as part of a theory they call differential
accumulation, which says firms seek to beat the average profit and capitalisation rather than maximise. According to this theory, periods of
mergers and acquisitions oscillate with periods of stagflation. When mergers and acquisitions are no longer politically feasible (governments
clamp down with anti-monopoly rules), stagflation is used as an alternative to have higher relative profit than the competition. With increasing
mergers and acquisitions, the power to implement stagflation increases.

Stagflation appears as a societal crisis, such as during the period of the oil crisis in the 70s and in 2007 to 2010. Inflation in stagflation, however,
doesn't affect all firms equally. Dominant firms are able to increase their own prices at a faster rate than competitors. While in the aggregate no
one appears to profit, differentially dominant firms improve their positions with higher relative profits and higher relative capitalisation.
Stagflation is not due to any actual supply shock, but because of the societal crisis that hints at a supply crisis. It is mostly a 20th and 21st
century phenomenon that has been mainly used by the "weapondollar-petrodollar coalition" creating or using Middle East crises for the benefit
of pecuniary interests.[26]

Demand-pull stagflation theory

Demand-pull stagflation theory explores the idea that stagflation can result exclusively from monetary shocks without any concurrent supply
shocks or negative shifts in economic output potential. Demand-pull theory describes a scenario where stagflation can occur following a period
of monetary policy implementations that cause inflation. This theory was first proposed in 1999 by Eduardo Loyo of Harvard University's John F.
Kennedy School of Government.[27]

Supply-side theory

Supply-side economics emerged as a response to US stagflation in the 1970s. It largely attributed inflation to the ending of the Bretton Woods
system in 1971 and the lack of a specific price reference in the subsequent monetary policies (Keynesian and Monetarism). Supply-side
economists asserted that the contraction component of stagflation resulted from an inflation-induced rise in real tax rates (see bracket creep)

Austrian School of economics

Adherents to the Austrian School maintain that creation of new money ex nihilo benefits the creators and early recipients of the new money
relative to late recipients. Money creation is not wealth creation; it merely allows early money recipients to outbid late recipients for resources,
goods, and services. Since the actual producers of wealth are typically late recipients, increases in the money supply weakens wealth formation
and undermines the rate of economic growth. Says Austrian economist Frank Shostak:

"The increase in the money supply rate of growth coupled with the slowdown in the rate of growth of goods produced is what the increase in
the rate of price inflation is all about. (Note that a price is the amount of money paid for a unit of a good.) What we have here is a faster
increase in price inflation and a decline in the rate of growth in the production of goods. But this is exactly what stagflation is all about, i.e., an
increase in price inflation and a fall in real economic growth. Popular opinion is that stagflation is totally made up. It seems therefore that the
phenomenon of stagflation is the normal outcome of loose monetary policy. This is in agreement with [Phelps and Friedman (PF)]. Contrary to
PF, however, we maintain that stagflation is not caused by the fact that in the short run people are fooled by the central bank. Stagflation is the

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natural result of monetary pumping which weakens the pace of economic growth and at the same time raises the rate of increase of the prices
of goods and services."[28]

Jane Jacobs and the influence of cities on stagflation

In 1984, journalist and activist Jane Jacobs proposed the failure of major macroeconomic theories[notes 1] to explain stagflation was due to their
focus on the nation as the salient unit of economic analysis, rather than the city.[29] She proposed that the key to avoiding stagflation was for a
nation to focus on the development of "import-replacing cities" that would experience economic ups and downs at different times, providing
overall national stability and avoiding widespread stagflation. According to Jacobs, import-replacing cities are those with developed economies
that balance their own production with domestic imports—so they can respond with flexibility as economic supply and demand cycles change.
While lauding her originality, clarity, and consistency, urban planning scholars have criticized Jacobs for not comparing her own ideas to those
of major theorists (e.g., Adam Smith, Karl Marx) with the same depth and breadth they developed, as well as a lack of scholarly
documentation.[30] Despite these issues, Jacobs' work is notable for having widespread public readership and influence on decision-makers.[31]

Responses

Stagflation undermined support for the Keynesian consensus.

Federal Reserve chairman Paul Volcker very sharply increased interest rates from 1979–1983 in what was called a "disinflationary scenario." After
U.S. prime interest rates had soared into the double-digits, inflation did come down; these interest rates were the highest long-term prime
interest rates that had ever existed in modern capital markets.[32] Volcker is often credited with having stopped at least the inflationary side of
stagflation, although the American economy also dipped into recession. Starting in approximately 1983, growth began a recovery. Both fiscal
stimulus and money supply growth were policy at this time. A five- to six-year jump in unemployment during the Volcker disinflation suggests
Volcker may have trusted unemployment to self-correct and return to its natural rate within a reasonable period.

See also

Agflation

Biflation

Chronic inflation

Deflation

Economic stagnation

Hyperinflation

Inflationism

Shrinkflation

Stagflation in the United States

Zero interest-rate policy

Notes

1. including those of Adam Smith, Karl Marx, John Stuart Mill, John Maynard Keynes, Irving Fisher, and Milton Friedman

References

Constructs such as ibid., loc. cit. and idem are discouraged by Wikipedia's style guide for footnotes, as they are easily broken. Please improve this article by replacing them
with named references (quick guide), or an abbreviated title. Learn more

1. Online Etymology Dictionary Douglas Harper, Historian. 4. N. Gregory Mankiw (25 September 2008). Principles of
http://dictionary.reference.com/browse/stagflation (accessed 5 Macroeconomics . Cengage Learning. p. 464. ISBN 0-324-58999-
May 2007). 9.

2. House of Commons Official Report (also known as Hansard), 17 5. Kollewe, Julia (15 February 2011). "Inflation: what you need to
November 1965, page 1,165. know" . UK: The Guardian. Archived from the original on 4
December 2013.
3. Edward Nelson; Kalin Nikolov (2002). Bank of England Working
Paper (PDF) (Report).Introduction, page 9.

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6. Helliwell, John (March 1988). "Comparative Macroeconomics of
Stagflation" . Journal of Economic Literature. 26 (1): 1–28.
JSTOR 2726607 .
7. J. Bradford DeLong (3 October 1998). "Supply Shocks: The
Dilemma of Stagflation" . University of California at Berkeley.
Archived from the original on 9 May 2008. Retrieved 24 January
2008.
8. Burda, Michael; Wyplosz, Charles (1997). "Macroeconomics: A
European Text, 2nd ed". Oxford University Press: 338–339.
9. Hall, Robert; John Taylor (1986). Macroeconomics: Theory,
Performance, and Policy. Norton. ISBN 0-393-95398-X.
10. Macroeconomics: Principles and Policy, 13th edition , "Ch. 10
Bringing in the Supply Side: Unemployment and Inflation?",
William J. Baumol, Alan S. Blinder, Cengage Learning, 2012, 2016.
11. Barsky, Robert; Kilian, Lutz (2000). "A Monetary Explanation of the
Great Stagflation of the 1970s" (PDF). University of Michigan.
12. Blanchard (2000), op. cit., Chap. 28, p. 541.
13. Abel, Andrew; Ben Bernanke; Andrew Abel (1995). "Chap. 11".
Macroeconomics (2nd ed.). Addison-Wesley. ISBN 0-201-54392-3.
14. Bronfenbrenner, Martin (1976). "Elements of Stagflation Theory".
Zeitschrift für Nationalökonomie. 36: 1–8.
doi:10.1007/BF01283912 .
15. Smith, V.Kerry (1979). "Scarcity and Growth Reconsidered". Johns
Hopkins Press for Resources for the Future.
16. Krautkraemer, Jeffrey (March 2002). "ECONOMICS OF SCARCITY:
STATE OF THE DEBATE". Washington State University.
17. "Over a Barrel" . Time Magazine. 3 October 1983. Retrieved
24 May 2010.
18. ("Panic at the Pump" . Time Magazine. 14 January 1974.
Retrieved 24 May 2010.
19. Helliwell, John. "Comparative Macroeconomics of Stagflation".
Journal of Economic Literature. 26 (1): 4.
Further reading
Homer, Sidney; Sylla, Richard Eugene; Sylla, Richard (1996). A History of Interest Rates . Rutgers University Press. ISBN 978-0-8135-2288-3. Retrieved
27 October 2008.
Last edited 4 days ago by TheUnbeholden
https://en.m.wikipedia.org/wiki/Stagflation
Stagflation - Wikipedia
20. Blanchard, Olivier (2009). Macroeconomics (Instructor's Review
Copy) (5th ed.). Prentice Hall. pp. 152, 583, 584, G–9. ISBN 0-13-
013306-X.
21. Blanchard, Olivier (2009). Macroeconomics (Instructor's Review
Copy) (5th ed.). Prentice Hall. pp. 153, 583, G–9. ISBN 0-13-
013306-X.
22. Abel & Bernanke (1995), op. cit., Ch. 11.
23. Abel & Bernanke (1995), op. cit., Ch. 11, pp. 378–9.
24. Barro, Robert; Vittorio Grilli (1994). European Macroeconomics.
Macmillan. p. 139. ISBN 0-333-57764-7.Ch. 8, Fig. 8.1.
25. Abel & Bernanke (1995), Ch. 11, pp. 376–7.
26. Nitzan, Jonathan (June 2001). "Regimes of differential
accumulation: mergers, stagflation and the logic of
globalization" . Review of International Political Economy. 8 (2):
226–274. doi:10.1080/09692290010033385 .
27. Loyo, Eduardo (June 1999). "Demand-Pull Stagflation (Draft
Working Paper)". National Bureau of Economic Research New
Working Papers.[1]
28. Frank Shostak (10 October 2006). "Did Phelps Really Explain
Stagflation?" . Mises Daily. Ludwig von Mises Institute. Retrieved
February 2011. Check date values in: |accessdate= (help)
29. Jacobs, Jane (1984). Cities and the Wealth of Nations. New York:
Random House. ISBN 0394480473.
30. Hill, David (1988). "Jane Jacobs' Ideas on Big, Diverse Cities: A
Review and Commentary". Journal of the American Planning
Association. 54 (3): 302–314. doi:10.1080/01944368808976491 .
31. Hill, David (1988). "Jane Jacobs' Ideas on Big, Diverse Cities: A
Review and Commentary". Journal of the American Planning
Association. 54 (3): 312. doi:10.1080/01944368808976491 .
32. (Homer, Sylla & Sylla 1996, p. 1)
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