What Is Stagflation and Why Is the World Worried about It?
With ever so prevalent global issues such as supply chain shortages, Russia’s invasion on Ukraine and continuing waves of COVID-19 cases globally, rising prices and high unemployment are starting to show worrying trends. Experts suggest the possibility of stagflation.
Stagflation is a term used to describe a situation in which the inflation rate is high, the economic growth rate slows, and unemployment remains steadily high. This presents a dire situation in which the lack of economic growth can cause unemployment rates to increase even more, resulting in an eventual downward spiral of the economy. A large part of why the fear of stagflation is so prevalent, is because of the complexity of fixing the issue. Monetary policy cannot solve both inflation and recession at the same time. Monetary policy can generally try to reduce inflation by raising interest rates or increase economic growth by reducing interest rates. Monetary policy cannot solve both inflation and recession at the same time. As a result, stagflation would present a great challenge to policymakers because of the effect of each respective countermeasure on the economy. Furthermore, as these measures would be implemented by the Federal Reserve, an additional worry could emerge. Due to the fact that the Federal Reserve has misjudged inflation and failed to make critical decisions which could have prevented inflation from becoming so high in the first place, there may be skepticism with the handling of the possible scenario of stagflation by the Fed.
In the 1970’s this fatal combination of high unemployment, high inflation and economic insecurity persisted for over a decade in the U.S., U.K. and parts of Europe. This problem occurred due to the OPEC oil embargo. This embargo was put in place against the United States by Arab nations in retaliation for the decision of the United States to resupply the Israeli military and to gain leverage in the post-war peace negotiations. This eventually led to a 300% increase in the price of oil. Shortly after, the consequences were substantial. These worryingly high energy prices drove up the cost of production which in turn slowed the economy. Between 1973 and 1975, the nation’s unemployment rate doubled to 9%. Annual inflation went as high as 14%, and only substantially recovered until the early 1980s after the Federal Reserve stepped in.
With the volatility of COVID-19 cases causing supply chain issues and the Russian invasion of Ukraine resulting in major uncertainty with oil and gas and causing the prices to spiral out of control, a chance of history repeating itself is possible. Fortunately, the United States economy has evolved in important ways since the crisis of the 70’s. As a result, seeing a repeat is unlikely. The United States has numerous measures which can be utilized to avoid a possibility of stagflation. If supply chain issues were to ease, revitalizing means of production, making valuable commodities more plentiful, would result in prices falling quickly. Additionally, the Federal Reserve can step in. As in the 1980’s, when the Fed under Paul Volcker, by raising interest rates high enough to dampen consumer demand, was able to heal the U.S. economy. Experts suggest similar measures could be implemented this time around. However, the risk still remains that the raise of interest rates could end up slowing growth, triggering a recession. Only time will tell.
