Definition of stagflation

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What is stagflation?

Stagflation is an economic expression for a period with weak or no growth and strong inflation. For stagflation to occur, the price increase and economic slowdown must be sustainable.

Causes and consequences of stagflation

Stagflation can occur following a major economic crisis. To boost growth, the central bank then applies an expansionary monetary policy. It then lowers its key rates and in some cases uses non-conventional instruments such as quantitative easing (QE). This has the effect ofincreasing the money supply.

This monetary creation can then generate high inflation and if economic growth is not on track, then a period of stagflation can set in. Price increases (measured by theconsumer price index) leads to a significant loss of purchasing power for households. As a result, consumption slows down and companies then lower their level of production. This leads to a significant increase in the unemployment rate. All these elements drive economic growth down.

Generally, to emerge from a period of stagflation, the central bank intensifies the mechanisms of monetary creation (banknote printing technique) to try to get out of slow growth. The problem is that it continues to drive up prices.

The phenomenon of stagflation may also be due to an increase in the price of raw materials (such as the rise in oil prices for example). This increase causes companies’ production costs to increase, to maintain their margins the companies increase the price of goods and services. If this situation persists, it can lead to sustained inflation and a drop in consumption. Economic growth declines and stagflation can take hold.

Example of stagflation

A well known example of stagflation followed the first oil crisis in 1973. It was the end of the Glorious Thirties and the sharp rise in oil prices significantly slowed economic activity and caused a sharp rise in inflation. This economic situation occurred in France and the United States. At that time, the United Kingdom had already been affected by stagflation for several years. It was British Prime Minister Iain Macleod who invented the term in 1965.

To get out of this economic situation, a policy to fight unemployment was then put in place by the various countries. In France, it was the Mitterand government that implemented a recovery policy as soon as it was elected in 1981. This policy was a total failure, unemployment was very high at the time and did not decline (and even continued to rise) and the inflation rate soared. Stagflation persisted. In 1983, Mitterand finally changed his policy. This was the beginning of the end. In many developed countries, Keynesianism gave way to monetarism. That was the dawn of austerity policy.

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