Explaining the Basic Concepts of Stagflation
Most of the economic woes in the past could be explained by an economic concept. For example, the recession that started in 2007 was due to sub-prime mortgage crises. More people are defaulting on their loans so the financial institution suffered a great deal of loss. The problem can be traced to a simple concept and although the solution is complicated, identifying the source in a macroeconomic manner helps in quickly finding a solution.
But there are instances in history wherein an economic situation is directly in contrast with another economic situation also happening at the same time. They should not exist at the same time because their basic concept is almost the reverse of the other. A perfect example of two economic concepts happening at the same time even though they are in contrast is stagflation. It is a term coined by Iaian Mclead, a British politician. He first presented the idea in his 1965 speech to the Parliament.
Stagflation is a combination of economic stagnation and inflation. In gist, the country is experiencing very slow to no growth at all in economic sense while experiencing inflation at the same time. This is an economic situation often feared by politicians and economists because it presents a challenge where one key solution is not possible.
The Problem with Stagnation and Inflation
These two economic concepts, theoretically, should not happen at the same time. Stagnation basically means that the economy is not moving forward but doesn’t experience losses either. This doesn’t necessarily means a “status quo” on economic standing but the economy is not moving forward so that they could earn more. The expected cash flow slows down because earnings are not that high. Stagnation is usually characterized with relatively high unemployment rate.
But the existence of cash flow tells another economic situation. The basic explanation on the phenomena of inflation is that there is an increased demand of certain commodities that it has outpaced supply. With an outpaced supply, the price of products will naturally increase. The existence of a demand means that consumers actually have funds to spend on certain products.
The existence of inflation (high demand) and stagnation (low income due to unemployment rate) at the same time is quite baffling. People do not have the funds to spend on something and yet there is an increased spending on certain commodities. Naturally, consumers will complain about inflation because they know that the economy is not going up but they still see price increase on various commodities.
The Challenge of Stagnation
Stagnation is a very difficult economic situation because the government, through its central bank, cannot enforce solutions through monetary policy. Stagnation warrants that the central bank lowers the interest rate to increase spending. With a lowered interest rate, people will be interested in taking out loans for various ventures and even in real estate. By lowering the interest rate, they could foster business loans which could slowly increase employment.
But this monetary policy step from the central bank is directly in contrast with inflation. During inflation, the government should try to deal with the problem by increasing the interest rate. This will quell increased spending as loans will require higher repayment. With an increased interest rate, consumers will be hesitant to spend so the demand for certain commodities is now lower. The end result is controlled inflation or the price of commodities will no longer increase.
These conflicting solutions explain why finding the solution to stagnation is never easy. But first, the government has to find the cause of the problem first.
Common Causes of Stagnation
The complexity of stagnation is a clue on the cause of stagnation. The complexity of the problem is actually comes from two complex causes. More often than not, stagnation happens when two or more parties create two different (often conflicting) decisions with an economic effect. For example, the government decided to clamp down on price increase while its monetary policy maker (central bank) decides to lower interest rates because of the perceived spending problem that could cause deflation.
Another cause of stagnation is the “shock supply”. This is basically a dramatic increase of supply that affected local production. This is actually caused by an outside factor. When there is an increased import of commodity, the local production is affected. People slowly start to lose jobs as they can no longer compete with imported goods.
The supply shock also refers to the increased need of a specific commodity. Take note that “need” is entirely different as consumers have to buy the said product. A good example of supply shock dealing with “need” is oil. As oil is increasingly required in various business transactions, the demand increased and so are the prices. The demand doesn’t necessarily mean that people have something to spend but they have to spend because oil is very important.
Solutions for Stagflation
Stagflation is an economic situation wherein the solution is in microeconomic control. Instead of simply setting simple monetary policies, the government has to be effective in dealing with various institutions facing the problem of stagflation. Another solution for stagflation is for the government, non-government organizations and businesses push for a more productive output with lesser input. This is the reason why oil efficiency is very important since it will control the increased need of oil even though there is an ongoing recession. By being productive without requiring a lot of input, stagflation could be controlled.