Slow economic growth accompanied by inflation is referred to as stagflation. When the economy is in this condition, prices rise, productivity falls, and unemployment increases.
What does stagflation mean?
Stagflation is highly detrimental to a nation’s economy. Left unchecked, it can spiral out of control and lead to further economic distress. A loss of jobs, low buying power in the hands of the people, and an increase in the cost of living characterize stagflation.
Getting an economy out of this condition is difficult. That’s because stagflation implies the simultaneous occurrence of slow growth as well as inflation. The accepted practice to get an economy growing faster is to increase the money supply within the system. But if this is done, inflation will rise. On the other hand, if the money supply is curtailed to reduce inflation, it will be difficult to get the economy back on the path to growth.
How, then, can stagflation be cured? Milton Friedman, an economist who received the Nobel Prize in 1976, proposed that the country’s central bank should focus on controlling inflation while the government should deregulate the economy to allow market forces to reallocate labor.
Example of stagflation
The American economy underwent a period of stagflation in the early 1970s. This was triggered by a steep rise in the price of oil imposed by the Organization of the Petroleum Exporting Countries (OPEC).
In 1973, OPEC reduced the volume of oil exports to the United States. This led to a four-fold rise in oil prices. Consequently, the cost of other goods also increased. To combat inflation, the government imposed a 90-day freeze on all wages and price increases. A 10% tariff was introduced on imports.
These measures were ineffective. GDP growth was negative in the third quarter of 1973. In 1974, growth was negative in three out of four quarters. Unemployment soared to 9% in 1975, and the inflation rate reached a level that was between 10% and 12% in 1974-75.
Stagflation is exceptionally harmful to the economy as it involves the simultaneous incidence of unemployment, slow growth, and inflation.