What causes stagflation?

What Causes Stagflation? According to the economists, there are two major types of causes of stagflation. They are, supply-side shocks and poor economic policies. These two main causes be occurred independently or can be occurred together.

What is Stagflation?

Stagflation is the economic situation that higher inflation, slower economic growth (stagnation), and increasing unemployment all happen simultaneously.

According to the above definition, we can identify three main characteristics of stagflation. They are high inflation, high unemployment, and slower economic growth. Let’s discuss them separately.

High inflation – High inflation means increasing the general price level of goods and services rapidly than increasing the nominal wages of the people. High inflation reduces the purchasing power of money. So, during stagflation, people can buy less amount of goods and services.

“Inflation means the increase in the general price level of goods and services”To read more about inflation, kindly click here

High unemployment – Unemployment is the percentage of unemployed individuals in a labor force. High unemployment means an increasing number of unemployed individuals. When there is a higher number of jobless people, they cannot spend money to buy goods and services. So, it is difficult to stimulate the economy.

Slower economic growth – An economy that has limited economic activity is one that is rarely expanding. Low economic activity is caused by high unemployment rates, and high inflation, as well as a number of other variables like a decline in consumer confidence and a drop in factory orders.

How to measure stagflation?

As economists, we do not have an exact mathematical formula to calculate stagflation. Most economists accept that it would not just be one or two quarters, but a continuous period of high inflation and slow growth.

You may be interested in to read more about “What is Stagflation? – With examples“

What Causes Stagflation?

According to the economists, there are two major types of causes of stagflation. They are,

1. Supply-side shocks

2. Poor economic policies

These two main causes be occurred independently or can be occurred together.

1. Supply-side shocks

This includes situation such as sudden spikes in globally required commodities and supply chain disruptions.

Sudden spikes in globally required commodities

There can be sharp rise in the global prices of some essential goods. The best example is the crude oil. Because crude oil is a necessity good for everyone and so that higher oil prices can crease a stagflation situation.

As a result of the higher oil prices, cost of the business organizations increases rapidly. Business organizations tend to pass these increasing costs to the consumers by increasing prices of goods and services and to employees by reducing wages or lay offing. Then both inflation and unemployment of the economy rises. As a result of higher inflation and higher unemployment, real income of the decreasing and percentage of jobless people are increasing. So, people cut their nonessential consumption spending. That means consumers reduce their demand for goods and services. So, business organizations have to decrease their output level and finally aggregate demand and aggregate supply of the economy decrease and economy grow very slow.

Example

From 2010 to 2012, the U.K. suffered supply-side shock stagflation, during which time rising oil prices dramatically increased inflation, reaching a peak of 5.2% in September 2011. Although it did not nearly enter a recession, the UK economy slowed down: GDP growth dropped from 1.9% in 2010 to 0.7% in 2012. By the end of 2011, unemployment, which was already high due to the 2008 financial crisis, had increased to 8.5%. It takes some times to end the supply-side shock inflation, although the commodity price rise stops. In the previous example, the oil price peaked in April 2011, but the U.K. economy continued to experience stagflation until 2012.

From an average of $71 per barrel in December 2021 to $109 per barrel in May 2022, the benchmark West Texas Intermediate (WTI) crude price has climbed dramatically. Impact of the oil prices increasing on many parties such as consumers, businesses of the US economy. Increases in oil prices are often assumed to lead to higher inflation and slower economic growth. The price of things created with petroleum products directly relates to oil prices in terms of inflation.

To read more, kindly click on “Impact of the oil prices on the US economy”.

Supply chain disruptions

Sometimes disruptions in the supply chain can create the stagflation. The most recent example is the COVID 19 pandemic. Similar to sudden changes in commodity prices, sharp increases in shipping, railroad, and haulage costs can be passed on to clients and employees. Even if the initial shock is only temporary, the stagflation that follows can take a year or longer to subside because of the lengthy lead times on shipping contracts.

Poor economic policies.

As a result of inappropriate and very weak economic policies, stagflation can occur. Sometimes the government may not able to implement suitable monetary policy, fiscal policy, supply-side economic policies, and so on.

What causes stagflation?