What is One Consequence of Stagflation

Both high inflation and loftier unemployment

In economics,
stagflation
or
recession-inflation
is a situation in which the inflation rate is loftier or increasing, the economic growth charge per unit slows, and unemployment remains steadily loftier. Information technology presents a dilemma for economic policy, since actions intended to lower inflation may exacerbate unemployment.

The term, a portmanteau of
stagnation
and
aggrandizement, is by and large attributed to Iain Macleod, a British Bourgeois Party politician who became Chancellor of the Exchequer in 1970. Macleod used the word in a 1965 speech communication to Parliament during a period of simultaneously high inflation and unemployment in the United kingdom of great britain and northern ireland.^{[i]
[2]
[iii]
[4]}
Warning the House of Commons of the gravity of the state of affairs, he said:

“We now have the worst of both worlds—not but inflation on the one side or stagnation on the other, but both of them together. We take a sort of ‘stagflation’ situation. And history, in modern terms, is indeed being made.”^[iii]
[5]

Macleod used the term once 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, just some of his work refers to the conditions that about would recognise as stagflation. In the version of Keynesian macroeconomic theory that was dominant between the finish of World War Two and the late 1970s, inflation and recession were regarded as mutually sectional, the relationship between the ii beingness described by the Phillips curve. Stagflation is very costly and difficult to eradicate once it starts, both in social terms and in budget deficits.

Dandy Inflation

[edit]

The term
stagflation, a portmanteau of
stagnation
and
inflation, was get-go coined during a menses of inflation and unemployment in the United Kingdom. The United Kingdom experienced an outbreak of inflation in the 1960s and 1970s. Every bit inflation rose then, British policy makers failed to recognise the primary role of monetary policy in controlling inflation. Instead, they attempted to utilise non-monetary policies and devices to answer to the economical crunch. Policy makers too made “inaccurate estimates of the caste of backlog need 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 market economies from 1973 to 1982.^[6]
Afterwards aggrandizement rates began to autumn 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

[edit]

Economists offer two main explanations for why stagflation occurs. Showtime, stagflation tin result when the economic system faces a supply shock, such as a rapid increase in the price of oil. An unfavourable state of affairs like that tends to raise prices at the aforementioned time as it slows economic growth past making production more costly and less profitable.^{[seven]
[viii]
[9]
[x]}

Second, the government can crusade stagflation if it creates policies that impairment manufacture while growing the money supply too quickly. These ii things would probably accept to occur simultaneously because policies that tedious economic growth practice not usually cause inflation, and policies that cause inflation practise not commonly dull economic growth.^{[
citation needed
]}

Supply shock

[edit]

At the start of the Six-Twenty-four hour period War when State of israel invaded the Sinai Peninsula all the manner downwards to the Suez Culvert. The Egyptian President Gamal Abdel Nasser, who was adjustment with the Soviet Matrimony, closed downward the Suez Culvert for 8 years starting in 1967 equally before long as the Six-Day War broke out. Oil through the Suez Culvert grade the Middle E to Europe had to be rerouted around the Continent of Africa. When Egypt tried to cross the Suez Canal and accept back the Sinai Peninsula in the Yom Kippur War in late 1973, that is what triggered the Oil embargo in Oct 1973, when Richard Nixon supported funding Israel with $2.two billion over the conflict. That resulted in OAPEC countries cutting production of oil and placing an embargo on oil exports to the United states and other countries backing Israel.^[11]
[12]

Excess demand

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Coin supply in the early 1970s increased at most 15% year over year in the U.s. and the Consumer price index lags behind almost one year or two. Britains budgetary policy was likewise dovish causing excess demand.
^{[thirteen]
[14]}

Cease of Bretton Woods system

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In the mid 1970s the Bretton Woods system was declining and countries stock-still commutation rate organisation between currencies started to float, and the Gilt standard where currencies were pegged to gilt was abandoned. The price of gold and oil became very volatile after many years of steadiness.^[xv]
[xvi]

Other reasons

[edit]

A wide range of various evidence has been compiled supporting the 2d explanation against the supply shock view that the 1970s stagflation was due to OPEC’south quadrupling of oil prices in October 1973. Data show that its seeds were sown during the late sixties and began to be reaped in that decade. Between 1968 and 1970 unemployment rose from three.six% to 4.9% while the CPI aggrandizement rose from 4.7% to 5.6%.^[17]
Further in the Michigan survey expected aggrandizement rose from 3.8% to 4.9% betwixt 1967 and 1970. The rise in expected inflation strongly supports the view that Expected Augmented Phillips Curve (EAPC) can explain the early, mild stagflation. Although the weakening economy was putting some downwards pressure on inflation overall aggrandizement rose in accordance with EAPC, as expected inflation kept rise. The stagflation became more severe in the early 1970s but was suppressed by the price controls and wage freeze imposed by President Nixon starting in August 1971 and through 1972. Merely when the controls were lifted in mid-1973 the CPI surged to viii.5%. Arguably, if there were no wage-price controls, the mini stagflation documented above would accept been conspicuously axiomatic before the October 1973 OPEC oil toll hike.^[18]

As for the directly impact of dollar depreciation on inflation, information once more imply that just every bit higher inflation shifted up the labor supply curve and made workers demand and get higher money wages, similarly a falling dollar made commodity producers demand higher prices to recoup for the dollar decline. Further, the weakening of the dollar, while exogeneous to oil prices, was itself a delayed response to rising inflation from 1968 onwards. This pattern of an overheated economy, leading to inflation, dollar depreciation, and and so to college oil prices and another bout of stagflation repeated itself in 1979.^[18]

Both explanations are offered in analyses of the 1970s stagflation in the West. It began with a big rise in oil prices, but then connected every bit central banks used excessively stimulative monetary policy to annul the resulting recession, thereby causing a price/wage spiral.^[xix]

Increased requirements on skill (educational activity and experience) on work force, for instance because of increased technical complexity, can crusade shortage on skilled employees and ascension salaries for them, at the same fourth dimension as uneducated piece of work tasks accept in part moved to low salary countries such as in Asia, causing high unemployment.

Postwar Keynesian and monetarist views

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Early on Keynesianism and monetarism

[edit]

Upwards 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, information technology became obvious that the relationship between inflation and employment levels was not necessarily stable: that is, the Phillips relationship could shift. Macroeconomists became more sceptical of Keynesian theories, and Keynesians themselves reconsidered their ideas in search of an explanation for stagflation.^[xx]

The explanation for the shift of the Phillips curve was initially provided past the monetarist economist Milton Friedman, and as well by Edmund Phelps. Both argued that when workers and firms begin to expect more than inflation, the Phillips bend shifts upwardly (meaning that more aggrandizement occurs at any given level of unemployment). In item, they suggested that if inflation lasted for several years, workers and firms would get-go to have information technology into account during wage negotiations, causing workers’ wages and firms’ costs to rise more chop-chop, thus farther increasing aggrandizement. While this idea was a severe criticism of early Keynesian theories, it was gradually accustomed past most Keynesians, and has been incorporated into New Keynesian economical models.

Neo-Keynesianism

[edit]

Neo-Keynesian theory distinguished two distinct kinds of inflation: demand-pull (acquired by shifts of the aggregate demand curve) and toll-push (caused by shifts of the aggregate supply curve). Stagflation, in this view, is caused by toll-button inflation. Cost-push inflation occurs when some strength 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 resource or an act of war.

Contemporary Keynesian analyses fence that stagflation can exist understood by distinguishing factors that affect amass demand from those that touch on amass 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 against amass supply fluctuations. In detail, an agin shock to aggregate supply, such every bit an increase in oil prices, can give ascent to stagflation.^[21]

Supply theory

[edit]

Fundamentals

[edit]

Supply theories 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, such as when at that place is a sudden real or relative scarcity of key commodities, natural resources, or natural capital letter needed to produce goods and services.^[22]
In this view, stagflation is thought to occur when in that location is an agin supply shock (for example, a sudden increase in the price of oil or a new tax) that causes a subsequent bound in the “price” of goods and services (ofttimes at the wholesale level). In technical terms, this results in wrinkle or negative shift in an economic system’south aggregate supply curve.^[23]

In the resource scarcity scenario (Zinam 1982), stagflation results when economical growth is inhibited past a restricted supply of raw materials.^[24]
[25]
That is, when the bodily 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 rise or standing 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 button inflation factors in neo-Keynesian theory (to a higher place). The way this plays out is that after supply stupor occurs, the economy first tries to maintain momentum. That is, consumers and businesses brainstorm paying college prices to maintain their level of need. The key bank may exacerbate this by increasing the coin supply, by lowering involvement rates for example, in an effort to combat a recession. The increased money supply props up the need for goods and services, though demand would normally drib during a recession.^{[
citation needed
]}

In the Keynesian model, college prices prompt increases in the supply of goods and services. However, during a supply shock (i.eastward., 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.^{[
citation needed
]}

Explaining the 1970s stagflation

[edit]

Following Richard Nixon’s imposition of wage and toll controls on 15 August 1971, an initial wave of cost-push shocks in bolt were blamed for causing spiraling prices. The 2nd major shock was the 1973 oil crunch, when the Organization of Petroleum Exporting Countries (OPEC) constrained the worldwide supply of oil.^[26]
Both events, combined with the overall energy shortage that characterised the 1970s, resulted in bodily or relative scarcity of raw materials. The toll controls resulted in shortages at the signal of purchase, causing, for case, queues of consumers at fuelling stations and increased production costs for manufacture.^[27]

Recent views

[edit]

Through the mid-1970s, information technology was alleged that none of the major macroeconomic models (Keynesian, New Classical, and monetarist) were able to explain stagflation.^[28]

After, an explanation was provided based on the effects of adverse supply shocks on both inflation and output.^[29]
According to Blanchard (2009), these agin events were 1 of two components of stagflation; the other was “ideas”—which Robert Lucas, 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”.^[xxx]
In this discussion, Blanchard hypothesizes that the recent oil toll increases could trigger another period of stagflation, although this has not yet happened (pg. 152).

Neoclassical views

[edit]

A purely neoclassical view of the macroeconomy rejects the idea that monetary policy can have real effects.^[31]
Neoclassical macroeconomists contend that real economical 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 aggrandizement. The neoclassical idea that nominal factors cannot have real effects is oft called
monetary neutrality
^[32]
or as well the
classical dichotomy.

Since the neoclassical viewpoint says that real phenomena similar unemployment are essentially unrelated to nominal phenomena like aggrandizement, a neoclassical economist would offer 2 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 await for jobs. Some other 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 chief neoclassical caption of aggrandizement is very unproblematic: information technology happens when the budgetary regime increase the money supply too much.^[33]

In the neoclassical viewpoint, the existent factors that determine output and unemployment impact the aggregate supply curve simply. The nominal factors that make up one’s mind inflation affect the aggregate demand curve simply.^[34]
When some adverse changes in existent factors are shifting the aggregate supply bend left at the same time that unwise monetary policies are shifting the aggregate demand curve right, the outcome is stagflation.

Thus the chief explanation for stagflation under a classical view of the economic system is but 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 accept alleged that the best way to destroy the Capitalist System was to debauch the currency. By a standing process of inflation, governments tin 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 economical police force on the side of devastation, and does it in a manner which not i man in a million is able to diagnose.

Keynes explicitly pointed out the human relationship between governments press money and aggrandizement.

The inflationism of the currency systems of Europe has proceeded to boggling lengths. The various belligerent Governments, unable, or also timid or as well brusque-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, past the force of constabulary expressed in the regulation of prices, contains in itself, withal, the seeds of terminal economic decay, and presently dries upwards the sources of ultimate supply. If a human is compelled to exchange the fruits of his labours for newspaper which, every bit experience soon teaches him, he cannot use to buy 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 organisation of compelling the commutation of commodities at what is not their existent relative value not just relaxes production, but leads finally to the waste matter and inefficiency of barter.

Keynes detailed the relationship between German authorities deficits and aggrandizement.

In Germany the total expenditure of the Empire, the Federal States, and the Communes in 1919–xx is estimated at 25 milliards of marks, of which not higher up 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 matter as a upkeep cannot be seriously considered to exist at all. Thus the menace of inflationism described above is not just a production of the war, of which peace begins the cure. Information technology is a continuing phenomenon of which the stop is non yet in sight.

Zimmermann conclusion

[edit]

While nearly economists believe that changes in money supply can have some existent furnishings in the brusque run, neoclassical and neo-Keynesian economists tend to agree that there are no long-run effects from changing the coin supply. Therefore, fifty-fifty economists who consider themselves neo-Keynesians usually believe that in the long run, coin is neutral. In other words, while neoclassical and neo-Keynesian models are oft seen equally competing points of view, they can also exist 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 equally a more appropriate clarification of the economy in the long run, when prices have sufficient time to adjust fully.^[35]

Therefore, while mainstream economists today might often aspect curt periods of stagflation (non more than a few years) to adverse changes in supply, they would not take this as an caption of very prolonged stagflation. More prolonged stagflation would be explained as the effect of inappropriate government policies: excessive regulation of product markets and labour markets leading to long-run stagnation, and excessive growth of the coin supply leading to long-run aggrandizement.^{[
citation needed
]}

Alternative views

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Every bit differential accumulation

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Political economists Jonathan Nitzan and Shimshon Bichler take proposed an explanation of stagflation as part of a theory they phone call differential accumulation, which says firms seek to shell 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 downward with anti-monopoly rules), stagflation is used as an alternative to have college relative profit than the contest. With increasing mergers and acquisitions, the ability to implement stagflation increases.

Stagflation appears as a societal crisis, such equally during the period of the oil crunch in the 70s and in 2007 to 2010. Inflation in stagflation, still, does not bear on all firms equally. Ascendant firms are able to increment their own prices at a faster rate than competitors. While in the amass no one appears to turn a profit, differentially ascendant firms improve their positions with higher relative profits and higher relative capitalisation. Stagflation is not due to whatever actual supply daze, but considering 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 do good of pecuniary interests.^[36]

Demand-pull stagflation theory

[edit]

Demand-pull stagflation theory explores the idea that stagflation tin can issue exclusively from monetary shocks without any concurrent supply shocks or negative shifts in economic output potential. Demand-pull theory describes a scenario where stagflation tin can occur post-obit a period of monetary policy implementations that crusade inflation. This theory was offset proposed in 1999 by Eduardo Loyo of Harvard University’south John F. Kennedy School of Authorities.^[37]

Supply-side theory

[edit]

Supply-side economics emerged every bit a response to Usa stagflation in the 1970s. It largely attributed inflation to the ending of the Bretton Wood system in 1971 and the lack of a specific toll 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 (run across subclass creep).^[23]

Austrian Schoolhouse of economics

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Adherents to the Austrian School maintain that creation of new money ex nihilo benefits the creators and early on recipients of the new money relative to late recipients. Money creation is not wealth cosmos; it only allows early coin recipients to outbid late recipients for resources, goods, and services. Since the actual producers of wealth are typically late recipients, increases in the coin supply weakens wealth germination and undermines the rate of economical growth. Austrian economist Frank Shostak says: “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. (Annotation that a toll is the amount of money paid for a unit of a expert.) What we accept 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 aggrandizement and a autumn in real economical growth. Pop opinion is that stagflation is totally made upwardly. It seems therefore that the phenomenon of stagflation is the normal consequence of loose monetary policy. This is in agreement with [Phelps and Friedman (PF)]. Contrary to PF, notwithstanding, we maintain that stagflation is not caused past the fact that in the brusk run people are fooled by the cardinal banking company. Stagflation is the natural result of monetary pumping which weakens the stride of economic growth and at the aforementioned time raises the rate of increase of the prices of goods and services.”^[38]

Jane Jacobs and the influence of cities on stagflation

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In 1984, journalist and activist Jane Jacobs proposed the failure of major macroeconomic theories^{[notes one]}
to explicate stagflation was due to their focus on the nation as the salient unit of measurement of economical analysis, rather than the city.^[39]
She proposed that the central to avoiding stagflation was for a nation to focus on the development of “import-replacing cities” that would experience economical ups and downs at dissimilar times, providing overall national stability and avoiding widespread stagflation. According to Jacobs, import-replacing cities are those with developed economies that balance their ain production with domestic imports—so they can respond with flexibility equally economical supply and demand cycles change. While lauding her originality, clarity, and consistency, urban planning scholars have criticised Jacobs for non comparing her own ideas to those of major theorists (e.yard., Adam Smith, Karl Marx) with the same depth and breadth they developed, as well as a lack of scholarly documentation.^[40]
Despite these issues, Jacobs’ piece of work is notable for having widespread public readership and influence on determination-makers.^[41]

Responses

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Stagflation undermined support for the Keynesian consensus.

Federal Reserve chairman Paul Volcker very sharply increased interest rates from 1979 to 1983 in what was called a “disinflationary scenario”. Subsequently U.South. prime interest rates had soared into the double-digits, inflation did come up down; these involvement rates were the highest long-term prime number interest rates that had ever existed in modern upper-case letter markets.^[42]
Volcker is ofttimes credited with having stopped at least the inflationary side of stagflation, although the American economic system besides dipped into recession. Starting in approximately 1983, growth began a recovery. Both fiscal stimulus and coin 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 charge per unit within a reasonable period.^{[
citation needed
]}

Come across also

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Notes

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References

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Further reading

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• Greenspan, Alan; Wooldridge, Adrian (2018).
  Capitalism in America: A History. New York: Penguin Press. pp. 299–326. ISBN978-0735222441.
  
• Homer, Sidney; Sylla, Richard Eugene; Sylla, Richard (1996).
  A History of Involvement Rates. Rutgers University Printing. ISBN978-0-8135-2288-3.
  
• Kynaston, David (2017).
  Till Fourth dimension’s Final Sand: A History of the Bank of England, 1694–2013. New York: Bloomsbury. pp. 501–587. ISBN978-1408868560.
  
• Meltzer, Allan H. (2009).
  A History of the Federal Reserve – Book two, Book ii: 1970–1986. Chicago: University of Chicago Press. pp. 865–1131. ISBN978-0226213514.
  
• Silber, William L. (2012).
  Volcker: The Triumph of Persistence. New York: Bloomsbury Printing. pp. 118–237. ISBN978-1608190706.
  
• Wells, Wyatt C. (1994).
  Economist in an Uncertain World: Arthur F. Burns and the Federal Reserve, 1970–1978. New York: Columbia University Press. pp. 121–228. ISBN978-0231084963.
  

External links

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• How Paul Volcker Stopped Inflation in the 1980s