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STAGFLATION
Stagflation is a term referring to transitional periods when the
economy is simultaneously
experiencing the twin evils of Inflation and high Unemployment,
a condition manyeconomists as late as the 1950s considered a
typical of the U.S. economy. Stagflation
occurs when the economy is moving from an inflationary period
(increasing prices, butlow unemployment) to a recessionary one
(decreasing or stagnant prices and increasing
unemployment). It is caused by an overheated economy. In periods
of moderate inflation,the usual reaction of business is to increase
production to capture the benefits of the
higher prices. But if the economy becomes overheated so that
price increases areunusually large and are the result of increases
in wages and/or the costs of machinery,
credit, or natural resources, the reaction of business firms is
to produce less and chargehigher prices.
The term first came into use in the mid-1970s, when inflation
soared to 12 percent andthe unemployment rate nearly doubled to 9
percent. This inflation was the result of the
quadrupling of oil prices by the Organization of Petroleum
Exporting Countries (OPEC),increases in the price of raw materials,
and the lifting of Vietnam-era government-
imposed Price and Wage Controls. At the same time, the economy
went into recession. In
1979 the high inflation rate was sent spiraling upward when OPEC
doubled petroleum
prices after the Iranian revolution. President Jimmy Carter
established the Council on
Wage and Price Stability, which sought voluntary cooperation
from workers and
manufacturers to hold down wage and price increases. The council
could not controlOPEC, however, and repeated oil-price hikes
thwarted the council's efforts. Years of
continued inflation and high unemployment was one of the factors
that undermined the
Carter presidency and Democratic Party proposals for welfare
reform, national health
insurance, and reform of labor law.
In 1980, after years of double-digit inflation the Federal
Reserve Board (Fed), under PaulVolcker, prodded banks to raise
interest rates to record levels of more than 20 percent to
induce a recession and break the inflation cycle. Subsequently
the Fed pursued amonetary policy designed to head off significant
increases in inflation, but in 19941995,
seven Fed increases in short-term interest rates failed to
moderate economic growth. Thisled to speculation that in a global
economy, domestic monetary policy may not be as
effective in controlling stagflation as previously thought.This
term was widely used in the 1970s to describe the co-existence of
stagnant economic
growth and high inflation. If we revisit the wonder years of
1970s, when the economywas over regulated, oil shocks had the
ability to paralyze the nation and the central
bankers still thought there was a trade off between growth and
inflation. In 1960seconomists Milton and Edmund Phelps challenged
the idea of permanent trade off
between unemployment and inflation, the experience of the 1970s
would seem to bearthem out as the inflation had reach double digits
and the unemployment had reached 9%.
The world economy has had several good years, global growth has
been strong, and thedivided between the developing countries and
developed world has narrowed, with India
and China leading the way, even Africa has been doing well, with
growth in excess of 5%
in 2007.
But the good times are ending. There have been worries for years
about the global
imbalance; Americas ill- conceived war in Iraq helped fuel to
quadrupling of oil price
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since 2003. in the 1970s, oil shocks lead to inflation in some
countries and to recessionelsewhere, as governments raised interest
rates to combat rising prices and some
economies faced the worst of both worlds; stagflation.The
administration now is hoping, somehow, to forestall a wave
foreclosure- thereby
passing the economys problems on to the next president, just as
it is doing with Iraqquagmire. Their chances of succeeding are
slim. For America today, the real question is
only whether there will by be short, sharp down turn, or a more
prolonged, but shallower,slowdown. Moreover, America has been
exporting its problems abroad, through the ever-
weaking dollar, for instance Europe; for instance, will find it
increasingly difficult toexport and in the world economy that had
rested on the foundations of a strong dollar the
consequent financial market instability will be costly for all.
At the time, there has been amassive global redistribution of
income from oil importers to oil exporters- a
disproportionate number of which are undemocratic states and
form workers everywhereto the very rich. It is not clear whether
workers everywhere will continue to accept
decline in their living standards in the name of an unbalanced
globalization whosepromises seem ever more elusive.
Indeed, the flip side of a world awash with liquidity is a world
facing depressed
aggregate demand. There is one positive note in this dismal
picture; the sources of global
growth today are more diverse than they were a decade ago. The
real engines of global
growth in recent years have been developing countries.
Nevertheless, slower growth or
possibly a recession in the worlds largest economy inevitably
has global consequences.There will be a global slowdown. If
monetary authorities respond appropriately to
growing inflationary pressure recognizing that much of it is
imported, and not a result
of excess domestic demand we may be able to manage our way
through it. But if they
raise interest rates relentlessly to meet inflation targets, we
should prepare for the worst:
another episode of stagflation. If the central banks go down
this path, they will no doubteventually succeed in wringing
inflation out of the system.
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