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ECONOMY
this period, rising unemployment and reduced business activity meant everyone had less money, yet surging inflation meant every dollar was worth a little bit less every day.
shock. That is, when something that is crucial to an entire economy, such as energy or labor, is suddenly in short supply or becomes more expensive. One obvious example is crude oil.
The problem is that the ways to fight either one of those two problems – high inflation, low growth – usually end up making the other one even worse.
Moreover, this experience with stagflation fundamentally altered Americans’ way of life and ushered in an era of fuel conservation and rationing not seen since World War II.
Oil is a key input into the production of many goods and services. When some event, like the Russian invasion of Ukraine, reduces the supply, the price of oil rises. Businesses in the U.S. and elsewhere that produce gasoline, tires and many other products experience rising transportation costs, which makes it less profitable to sell stuff to consumers or other companies no matter the price.
The Federal Reserve, for example, could raise interest rates – as it’s widely expected to do on March 16, 2022 – which can help reduce inflation. But that also hurts economic activity and overall growth, because it puts the breaks on borrowing and investment. Or policymakers could try to spur more economic growth – whether through government stimulus or keeping interest rates low – but that would likely end up fueling more inflation.
WHAT CAUSES STAGFLATION? The causes of stagflation are still hotly debated by economists. Before the 1970s, they generally didn’t believe it was possible to have both high inflation and high unemployment from a stagnating economy. Economists had thought that unemployment and inflation were inversely linked. There are a few different theories on how both high inflation and a stagnating economy can coexist, however. The most common is that stagflation happens when there is a so-called negative supply
As a result, a great number of producers decrease their production, which decreases aggregate supply. This decrease leads to falling national output and an increased unemployment rate together with higher overall prices.
CAN THE US DO ANYTHING ABOUT IT? For policymakers, there’s almost nothing worse than the specter of stagflation.
Put another way, you’re damned if you do, damned if you don’t. And that means solving the problem may simply depend on circumstances out of U.S. policymakers’ control, such as an end to the crisis in Ukraine or finding ways to immediately increase oil supply – which is tricky. In other words, stagflation is a nightmare you never want to live through. PAGE 43
