Stagflation

Stagflation refers to a serious problem in an economy in which prices are high, jobs are scarce, and productivity is low. Stagflation combines the terms “stagnation” and “inflation.” Here, stagnation refers to a struggling economy marked by a lull or decrease in productivity and a heavy loss of employment. Inflation refers to an economic principle relating to the changing value of currency; basically, it means that money is worth less, and goods and services cost more.

Although economic factors usually work in conjunction to retain some balance in an economic system, some outside influences may upset this balance. One such factor is a negative supply shock, or a sudden rarity of a vital factor in an economy (such as oil), which causes the cost of that factor to rise sharply and prohibitively. At these times, the give-and-take relationship between economic factors may break. The resulting situation, known as stagflation, is marked by people losing jobs, businesses producing less, and goods and services costing more.

Stagflation is a rare event; prior to the 1960s, some economists even doubted it could happen. However, events in the 1970s brought serious stagflation to the United States and other countries. Troubling events of the 2020s, including the COVID-19 pandemic and the Russian invasion of Ukraine, have led to major economic disruptions on a global scale. Many economists believe that the United States and other countries may be on the brink of a new period of stagflation if leaders fail to address the problems effectively. Further, although concerns about inflation and potential economic slowdowns manifested into the mid-2020s, indicators showed the economy was still growing and unemployment remained low. These conditions rendered stagflation unlikely.

Background

An economy is the system by which people make, save, and spend money. Economists, or scientists who study the economy, have identified dozens of important variables that help to determine how economies work on both small and large scales. Economists may study the economies of individuals, family groups, towns, cities, states, regions, or countries. Increasingly, economists analyze the global economy or the overall picture of economic activity around the world.

On the macroeconomic scale, or the large scale, three variables are generally considered the most important. One of these variables is the gross domestic product, which is the total amount of goods and services produced in a country or region. Analyzing the gross domestic product provides a quick measure of how well a large-scale economy is doing in terms of productivity.

The second main variable is unemployment. The opposite of employment, unemployment refers to the ratio of people who are potentially able to work but are not currently working. Usually expressed as a percentage, unemployment is a measure of the job situation in a country or region; a high unemployment percentage is typically a bad sign, as it indicates many people are not being productive and not earning sufficient money.

The third main variable is inflation. Many people assume that the value of money and the cost of goods remain more or less static over time. In reality, these factors are in a near-constant state of change. High inflation means that currency has less buying power, and goods and services will cost more. In general, inflation continues to rise over time, meaning that people must earn more money to be able to afford the things they need and want. For example, a loaf of bread might have only cost ten cents in 1960, whereas a loaf of bread of similar quality might cost three dollars in 2022. Theoretically, inflated prices are linked to higher income, meaning that workers generally get more pay to help offset the rising cost of living.

Economists may lean heavily on these three variables and study them in great detail, sometimes individually and sometimes in conjunction with each other. Frequently, these variables overlap, with each variable affecting the others in some way. Economists may often successfully predict how variables can change each other. For instance, if the gross domestic product is high and unemployment is low, inflation usually increases. Alternately, if the inflation is low, gross domestic product is generally also low, and unemployment is usually higher. In these ways, positive variables are usually balanced against negative variables, leading to an imperfect but healthy and sustainable economy.

Until the 1960s, many economists believed these factors would always behave in a largely predictable manner. However, history proved that the factors of an economy can indeed stop working in coordination, and the typical economic equations may cease to apply. Sometimes, the unusual situation will break the balance and lead to an economic situation that is all negative and reflects both poor economic growth and high costs at the same time. Economists have coined the term stagflation to explain this rare occurrence.

Overview

The word stagflation is a portmanteau created by combining the words stagnation and inflation. Stagnation refers to a state of being in a slow or non-existent state of advancement, while inflation is used in its economic sense relating to rising costs of goods and services. In stagflation, the gross domestic product is mostly level or falling and unemployment is high, indicating a stagnant economy—while, at the same time, inflation is causing prices to rise.

The term can be traced back at least to 1965 when Iain Macleod, a leader in the British Conservative Party, made a speech to the House of Commons. He introduced the word stagflation and its meaning and described the situation as “the worst of both worlds.” In the coming years, the word would spread internationally and describe a growing and lasting period of economic hardship.

Many economists once thought a situation such as stagflation would be impossible in a developed, modern economy. However, it has occurred, and economists have created several theories to help explain why. The most widely accepted theory relates to the occurrence of a negative supply shock, or a situation in which a vital factor in an economy suddenly becomes considerably rarer and/or more expensive. One factor prone to such shocks, and which has contributed greatly to stagflation in the past, is energy.

Oil, in particular, is a vital part of the global economy, necessary not only for the production of countless goods but also for their transportation by land, air, or sea. However, oil is also prone to sudden changes in availability. Because oil occurs in large amounts only in certain areas, any instability in those areas can cause the oil supply to drop sharply. Wars, natural disasters, and political and economic disagreements may lead to oil supplies dropping in a very brief time and with very little warning. This drop in supply inevitably brings a rise in cost, making this necessary commodity both rarer and more expensive.

Such a shock to an economy is likely to hurt production (decreasing gross domestic product), cause workers to lose jobs (increasing unemployment), and cause the cost of goods and services to rise (increasing inflation)—thus creating the perfect setup for stagflation.

Oil was a major contributor to a damaging episode of stagflation that hit the United States in the 1970s. OPEC, an international organization of countries that produce large quantities of oil, called for an embargo, or a reduction of supply of oil. Because of this embargo, between 1973 and 1975, the cost of oil doubled. Suddenly, every economic process that required oil was twice as expensive to perform. The United States, which relied heavily upon oil from Organization of the Petroleum Exporting Countries (OPEC) nations, experienced a major and sudden economic predicament. The gross domestic product fell sharply. Many people lost their jobs, doubling the unemployment rate within two years. At the same time, inflation jumped, raising the cost of goods and services in almost every sector.

This stagflation badly hurt the economy and the United States in general. For years, people had to carefully ration their use of oil, as well as struggle to acquire the goods and services they needed that were no longer affordable. They had less money, and the money they had was worth less. The economic cutbacks of that period were the greatest in the United States since World War II (1939–1945) and lasted for about ten years before the economy finally found balance again.

In 2022, the threat of stagflation again fell across the United States and many other countries. The United States was at that time recovering from the long and damaging COVID-19 pandemic, as well as struggling with a variety of political and social tensions. The Russian invasion of Ukraine, along with subsequent sanctions against Russia, caused wide-scale changes to the balance of the world economy as well as the availability and price of oil. Oil prices in the United States and elsewhere skyrocketed, hurting economic activity.

These changes compounded existing stresses in the economy, resulting in a situation in which the gross domestic product appeared to be slowing, unemployment threatened to rise, and inflation surged at an uncontrollable rate. Many economists believed that a harsh, lengthy period of stagflation could lie ahead, perhaps severe enough to rival that of the 1970s, if leaders could find ways to avoid it. Although inflation was still a concern into the mid-2020s, the unemployment rate remained low and the economy showed signs of growth, lessening feats of stagflation.

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