Anyone who lived through the economic hardships of the late 1970s is familiar with the term "stagflation," although many people not old enough to remember gas rationing amidst the Carter administration may be completely unfamiliar with the term. But given the current economic climate of fear and uncertainty, it may be time for a refresher course on the meaning of the term, what it represents, and the difficulties faced in trying to correct it.
Stagflation
The term stagflation is a combination of "economic stagnation" and "inflation," two economic phenomena that were for years thought to be contradictory. Economic stagnation is a long-term period of slow economic growth, usually less than 2 or 3% per year. On the other hand, inflation, in this situation, is taken to mean rapid devaluing of money. Money loses purchasing power, meaning that ever increasing amounts of money are required to purchase goods. One of the most famous cases of inflation was during the interwar years in Weimar Republic Germany, in which it took a wheelbarrow full of Deutschmarks to buy a loaf of bread.
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In traditional Keynesian economics, these two problems are viewed as on different ends of the seesaw - if inflation is up, then stagnation must be down, and vice versa. However, by the time the term "stagflation" was coined in the mid-'60s by English politician Iain Macleod, it was understood that certain economic conditions could cause stagnation and inflation to go hand in hand.
What Causes Stagflation?
One of the ways in which stagflation can occur is when a society receives a supply shock of a necessary commodity, such as oil. If a country is a major oil importer (such as the United States), and there is a sudden reduction in the availability of oil (as during the OPEC oil embargo in the 1970s), prices will rise at the same time that the economy slows due to the shortage in a key power supply. Additionally, stagflation can occur when banks allow the money supply to grow (causing inflation) while the government regulates goods and markets too excessively (causing stagnation).
The difficult thing about stagflation is that traditional means of reducing inflation will increase stagnation, and vice versa. Governments facing this problem is that they have to find a means to balance out the two ends of the problem and tip them back into balance. If not fixed effectively, it can spiral into even greater economic problems.
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