Economics students looking for the explanation to stagflation should know that this is a term that denotes a very unhealthy situation for a country to find itself in. It is a combination of the two words 'Stagnation' and 'Inflation' so it really cannot mean anything good. A state of affairs of a nation where the rate of unemployment and the rate of inflation are concurrently rising is known as stagflation, and this is a situation that requires immediate attention.
Fixing the problem requires careful analysis and implementation of monetary policy because too much focus on one problem can cause the other issue to rise to dangerous levels. Obviously no country wants to experience unemployment and inflation, and when they both occur at the same time it can spell doom and gloom for one and all.
Definition of Stagflation
The term was first used by Iain Macleod in a speech to the British Parliament in 1965, and since then it has aptly come to describe a situation where the unemployment rate and the inflation rate are constantly rising together. This is the official definition and there really could be no easier way to define it.
The causes can be seen in two different lights. In the first situation, stagflation will occur when a country suddenly receives low supply of an item it depends heavily on (Shock Theory). As a result of this, the costs of production become very high in the country, and any economic process becomes unprofitable. As a result of this, prices of all commodities rise further up and the rate of employment falls down. This leads to a very unfavorable condition in the country.
Understanding stagflation in economics also requires students to see the other possible cause of the condition. This is when both the rates of unemployment and inflation rise of their own accord due to faulty macroeconomic policies undertaken by the Government. When the Government increases the money supply in the economy it leads to inflation. On the other hand, when the Government heavily regulates the free-flowing markets, it leads to stagnation and unemployment. Both these scenarios can occur individually, or concurrently as well.
Solutions of Stagflation
Excessive levels will ultimately lead to slow economic growth and economic recession in the economy, so it is necessary to fix the problem as soon as possible. The 1970s saw a period of stagflation in the US economy due to rising prices of crude oil, and this ultimately impacted the United Kingdom and other countries of the world as well. In order to control the economy, applicable monetary policies need to be implemented by the Federal Government.
The idea is to control inflation levels in the country, and this can only be achieved by controlling the money supply in the country. It is for this reason that governments need to understand stagflation and how to go about solving it. When the economy is growing, the Government should increase interest rates so that there is less money in circulation. On the other hand, when the economy is slowing the Government should lower interest rates so that there is more money in circulation. This will control the money supply, and hence the inflation levels, also known as deflation.
Ensuring that employment levels are maintained at a respectable level will also help stabilize the economy. Balancing the two variables is something that requires experience and patience, and this is why many countries fall into the trap. Since unemployment rates and inflation rates should not rise together, the Government needs to take preventive measures as and when it can.
The subject of economics is very vast and intertwined, so one needs to look into it with greater detail to understand the true complexity of the situation of stagflation, and all the implications that it brings with it.
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