You may have heard the word stagflation before, but do you know what it is? Stagflation is a word penned from combining stagnation and inflation, and was first used in 1965 by a British politician by the name of Lain Macleod. He warned of a time when this could occur, where the inflation rate was higher than the rate of economic growth.
Relationship Between Unemployment and Inflation
At the time of Mr. Macleod’s statement, the United States was still going through a post war boom, and the government believed that the relationship between unemployment and inflation was stable and did not think there was anything to be worried about. A charting system called the Philip’s Curve showed that generally, as unemployment went down, inflation went up, and vice versa. So the government decided to boost the demand for goods and services while keeping unemployment low, thinking that this would create a safely rising inflation rate. Unfortunately though, this backfired on them. At first workers expected a higher pay due to the inflation rate and employers generally complied to this, but as the inflation rate got out of hand, workers didn’t want to work harder for less wages, and unemployment rose, while inflation was still rising as well.
This unbalanced relationship between wages and prices was not the only thing that caused the stagflation, however. In 1973, OPEC’s oil embargo raised oil prices to levels not seen before. This affected prices at the gas pumps and in various U.S. industries, and caused a lot of fuel shortages. From 1970 through 1979 the inflation rates continued to rise at exorbitant rates not seen before, and this time period also saw a halt to the stock market.
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Government Spending and Borrowing
The federal government and President Carter tried several ways to bring stabilization back to the country, including a lot of government spending and borrowing, plus putting guidelines on wages and prices. These tactics only seemed to make matters worse. It took until 1979, when federal chairman Paul Vocker started raising interest rates, cutting the flow of money going to the economy. It caused high unemployment and a recession in the 1980’s, but eventually things evened out again, once again bringing the economy to a stable level.
This past November in 2010, the Federal Reserve launched the latest stimulus, called QE2. The reason stated for this was that without more stimulation, the country could go into a period of falling prices. But instead this stimulus has caused global inflation, and some experts fear that this could put the U.S. into another time of stagflation. Other countries such as China are already seeing the results of the global inflation, with rioting breaking out in several major cities. With the already rapidly rising costs for fuel and food, some see a similar time in the U.S. to the period during the 1970’s, and believe we will have to brace ourselves for another stagflation. Some experts, however, say a stagflation is not possible because of the high unemployment rate since in order for it to be a true stagflation, employment would be high and rising along with the inflation.
What's your thoughts? Should we be worried about staglation?