During a period of stagflation, the GDP goes down and the prices of necessary goods and commodities go up. It is a complex predicament for policymakers and the governments as the measures taken here to control inflation will also result in an increase in unemployment.
WORKING OF STAGFLATION
Stagflation overrules the concept of demand and supply. It opposes the proposed model by the keynesian economists with respect to GDP and its correlation with inflation. Stagflation is nothing but economic stagnation coinciding with the inflation i.e. stagnation + inflation results in stagflation.
A country facing stagflation goes through high commodity prices, lessened purchasing power, business shutdowns, poor GDP, decline in spending of customers, and increase of unemployment brought by the layoffs of corporations. The country went through stagflation in the 1970s. Many economists blame the central reserves' extravagant supply of money and circulation for the debacle in the economy. The motive behind increasing cash flows was a strategy to improve market conditions for labour.
Countries are afraid of stagflation as it is complex and tricky to handle. Measures taken to control inflation will further increase recession. But on the other side, if steps are taken to improve employment, it further increases inflation. If such a scenario persists in the long run, the economy may end up with a high level of poverty and unemployment with decelerated progress.
CAUSES OF STAGFLATION
The major cause behind such an economic scenario is monetary policy. Past instances of inflation recession bring this in highlight. Wrongly devised fiscal policies can have a drastic impact. Sometimes , the RBI i.e. central bank induces an excessive supply of money to reduce the unemployment and bring up the GDP. The rising inflation in return increases commodity prices and depreciates the purchasing power of the money.
To deal with the issues, economies generally increase taxes. This is done so to deal mainly with the commodity prices and bring them down. These 2 different measures, if adopted together in the long term, may have significant adverse effects on the economy. The worst case situation here will be very high inflation with a corresponding recession.
WHY IS IT BAD?
Stagflation is a sword and that too double edged that adversely affects the economy. Adding to it, the measures taken to control the inflation will further cause an increase in unemployment. Identically, measures taken to consolidate unemployment will result in increased inflation. Unlike inflation or deflation, there is no standard protocol or measures to deal with this phenomenon.
During the economic situation, the price of everything goes up and becomes expensive, the purchasing power of the currency drops. Rather than spending on lifestyle and leisure, people stick to basic requirements. Hence, the demand for such commodities falls significantly. Resulting in companies facing losses. Reduced earnings and profits in turn starts a chain reaction which results in layoffs, wages cut and ultimately businesses get shut. The country’s GDP falls and recession coincides with inflation.
- Stagflation is an economic phenomenon where inflation goes up while the GDP becomes low or constant. Moreover, the level of employment plummets.
- It is contrary to the Keynesian macroeconomics theory which explains the trade-off between inflation and unemployment.
- The US struggled with stagflation in the 1970s. The fed reserve chairman took all the necessary steps in 1979. He implemented numerous contractionary monetary policies. He managed to bring down the rate of inflation.