Definition of Stagflation
Stagflation is a portmanteau of “stagnation” and “inflation” used to describe an economic scenario where stagnant economic growth coexists with high inflation. Unlike typical periods of economic downturns, stagflation is marked by rising prices for goods and services despite sluggish or zero growth rates, often leading to increased unemployment rates.
Examples
-
1970s United States:
- The term stagflation first gained prominence during the 1970s, a decade marked by the simultaneous occurrence of high inflation, stagnant economic growth, and rising unemployment.
- The 1973 oil crisis played a significant role in this period, as OPEC’s oil embargo led to skyrocketing energy prices, contributing to inflation and negative economic impacts.
- Stock markets performed poorly due to weak corporate earnings, while tangible assets like real estate with short-term leases fared better.
-
UK During the 1970s:
- The UK experienced stagflation due to a series of economic shocks, incorporating rapidly rising oil prices and other inflationary pressures combined with industrial action and economic stagnation.
Frequently Asked Questions (FAQs)
Q1: What causes stagflation?
A1: Stagflation can be caused by a combination of supply shocks (such as an increase in the cost of important commodities like oil) and fiscal or monetary policies that limit economic growth.
Q2: Why is stagflation particularly concerning for policymakers?
A2: Traditional policy tools are inadequate because measures to control inflation (like raising interest rates) can exacerbate unemployment and economic stagnation, while measures to spur growth (like lowering interest rates or increasing fiscal spending) can worsen inflation.
Q3: How did the Federal Reserve respond to stagflation in the 1970s?
A3: The Federal Reserve, under Paul Volcker, responded to stagflation through tight monetary policies, including high interest rates to curb inflation, which addressed inflation but at the cost of a sharp economic recession.
Q4: What assets perform well during stagflation?
A4: During periods of stagflation, tangible assets such as real estate without long-term fixed-income leases and commodities typically perform better as they act as hedges against inflation.
Related Terms
- Inflation: A sustained increase in the general price level of goods and services in an economy over a period of time.
- Economic Stagnation: A prolonged period of slow economic growth, traditionally measured by the growth rate of the GDP.
- Unemployment: The situation where individuals who are capable of working are not finding work, reflected in a higher unemployment rate.
- Supply Shock: An unexpected event that changes the supply of a product or commodity, resulting in a sudden change in its price.
- Monetary Policy: Economic policies implemented by a central bank to control the supply of money, primarily through interest rates.
Online Resources
- Investopedia Stagflation
- Federal Reserve History on Stagflation
- The Balance - Stagflation and Its Impact
References
- Humphrey, Thomas M. “Historical Origins of Stagflation.” Federal Reserve Bank of Richmond, Economic Review (1980).
- Blinder, Alan S. “The Anatomy of Double-Digit Inflation in the 1970s.” The Wharton Quarterly, (1982).
Suggested Books for Further Studies
- Blinder, Alan S. “Hard Heads, Soft Hearts: Tough-Minded Economics for a Just Society.” Addison-Wesley.
- Samuelson, Robert J., “The Great Inflation and Its Aftermath: The Past and Future of American Affluence.” Random House.
Real Estate Basics: Stagflation Fundamentals Quiz
### Which of the following scenarios best defines stagflation?
- [ ] Rapid economic growth and falling prices.
- [ ] High inflation and high economic growth.
- [x] High inflation and economic stagnation with rising unemployment.
- [ ] Decreasing inflation and high employment.
> **Explanation:** Stagflation is defined as a period of high inflation combined with stagnant economic growth and rising unemployment.
### What was one of the main causes of stagflation in the 1970s?
- [x] Oil price shock.
- [ ] A stock market crash.
- [ ] Technological advancements.
- [ ] Increased labor productivity.
> **Explanation:** One of the primary causes of stagflation in the 1970s was the oil price shock due to the OPEC oil embargo, which led to soaring energy prices.
### Why is stagflation considered a difficult economic condition for policymakers?
- [ ] Because it only lasts for a few months.
- [x] Because actions to reduce inflation can worsen economic stagnation and vice versa.
- [ ] Because low interest rates alone can easily solve stagflation.
- [ ] Because it predominantly affects the agricultural sector.
> **Explanation:** Stagflation is challenging because typical policy measures for reducing inflation (such as raising interest rates) can further worsen economic stagnation and unemployment.
### What was the Federal Reserve's response to stagflation in the 1970s?
- [x] Implementing tight monetary policies and raising interest rates.
- [ ] Lowering interest rates to spur economic growth.
- [ ] Increasing fiscal spending dramatically.
- [ ] Removing all trade barriers.
> **Explanation:** The Federal Reserve implemented tight monetary policies and significantly raised interest rates to curb inflation, leading to a sharp economic recession.
### How do tangible real estate assets typically perform during stagflation?
- [ ] They lose value faster than stocks.
- [x] They perform better, especially without long-term fixed-income leases.
- [ ] They perform poorly as inflation rises.
- [ ] They do not change in value.
> **Explanation:** Tangible real estate assets often perform better during stagflation, particularly when not tied to long-term fixed-income leases as they act as hedges against inflation.
### Which term describes a prolonged period of slow economic growth?
- [ ] Hyperinflation.
- [ ] Deflation.
- [ ] Economic boom.
- [x] Economic stagnation.
> **Explanation:** Economic stagnation refers to a prolonged period of slow economic growth.
### Which of the following is NOT a characteristic of stagflation?
- [ ] High inflation.
- [ ] Economic stagnation.
- [ ] Rising unemployment.
- [x] High economic growth.
> **Explanation:** Stagflation is characterized by high inflation, economic stagnation, and rising unemployment, not by high economic growth.
### What typically exacerbates inflation during a period of stagflation?
- [x] Supply shocks, like a sudden increase in oil prices.
- [ ] A financial crisis.
- [ ] A decline in consumer spending.
- [ ] A high savings rate.
> **Explanation:** Supply shocks, such as an unexpected and rapid increase in oil prices, can exacerbate inflation during stagflation.
### Why might traditional monetary policy be ineffective during stagflation?
- [ ] Because inflation disappears quickly.
- [ ] Because it always results in higher unemployment.
- [ ] Because it cannot be applied during recessions.
- [x] Because actions to reduce inflation can further decrease economic growth and increase unemployment.
> **Explanation:** Traditional monetary policy may be ineffective during stagflation because actions aimed at reducing inflation can further hamper economic growth and increase unemployment.
### How did the 1973 oil crisis impact stagflation?
- [x] It led to a significant rise in energy prices, exacerbating inflation.
- [ ] It reduced global trade, decreasing inflation.
- [ ] It led to technological advancements that curbed stagnation.
- [ ] It caused deflation in global markets.
> **Explanation:** The 1973 oil crisis contributed to a significant rise in energy prices, which exacerbated inflation and contributed to the period of stagflation in the 1970s.
