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Stagflation is the unenviable combination of inflation with stagnant economic development. Often occurring in heavily indebted economies, stagflation is a difficult spiral to break out of as additional spending to stimulate the economy typically worsens inflation, while measures to reduce inflation often further stunt economic growth and market activity. There are numerous potential causes for stagflation, and the best-known outbreak took place in some developed economies in the 1970s.
The term stagflation was invented to describe the situation in the US and UK in the 1970s, with more recent examples in Argentina and elsewhere in South America. Typically, stagflation has not impacted Asian or Middle Eastern economies, in part because energy and oil prices both contribute to and are increased by stagflation. During the 1970s, the price of oil rose sharply, inflation rose to over 20% and economic growth stalled.
The usual tools of central banks to deal with inflation have the side effect of slowing economic growth, as they make borrowing more expensive. This means central banks are often powerless to act against stagflation without further worsening economic conditions. Likewise, the usual methods of stimulating economic growth – increasing spending, cutting taxes, or lowering interest rates – can all make inflation worse as they either increase the money supply or facilitate cheap borrowing.
The result of periods of stagflation is that living standards and spending power decline, often further locking in poor economic performance. The period of stagflation seen in developed economies in the 1970s only ended with productivity growth, the discovery of new natural resources, and in some cases a radical restructuring of the state in the following decade. This has contributed to stagflation’s reputation as a tough-to-solve economic problem.
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