Stagflation (Research Paper Sample)

Essay
Economics
Number of Pages: 2
8th December 2015
Stagflation: Explanation and Illustration
Stagflation is a situation where the level of inflation is high due to high price of goods and the level of unemployment is also high due to a stagnant economic growth. Therefore, stagflation is a combination of stagnant economic growth and inflation. Until the 1970s, many of the Economists at the time believed that inflation and Unemployment had an inverse relationship, in that when inflation occurred, there would a low unemployment rates. This was because an increase in commodity prices would enable firms to increase expansion-wise and thus more people would be hired.
This situation happened in the 1970s when the oil crisis hit the United States. A deep recession caused by high interest rates was the step the Federal Reserve Bank took to correct this situation and stabilize the economy. This made many economic segments be unable to borrow thus reducing the money supply in the economy. However, the basic consumer suffers the most in such a case since commodities are rather expensive and they can hardly get jobs to provide their basic needs. Thus, consumers are forced to cut their spending in a hasty way inorder for them to survive in such an economy (Lisa "An Explanation of Stagflation”).
There are two main causes of stagflation that are widely accepted by many Economists. Those who believe in the Keynesian theory refer to supply shocks as the cause. High price levels of either energy or food, which increases the level of supply of money, makes too much money to chase few commodities. Those other Economists of the supply side believe that introduction of high taxes, business regulation and a state welfare that is persistent enable people to live in good conditions and thus no need to work (Thompson "Stagflation”).
An economy will commence with a record of increased growth in the spending habits, which is caused by increased money supply. This causes prices to shoot up, causing great inflation and reduced unemployment. Friedman, a renowned Economist, believed that decline in unemployment caused high expectancy of inflation to increase further, resulting to low wages. This would attract employees demanding for higher wages, which will lead to increased unemployment but within the normal rate.
Stagflation is mostly caused by a supply side shock, that is, where high prices in commodities causes rising cost of business operations and thus the aggregate supply (AS) will shift leftwards. This will result in high inflation and low output/unemployment rates. The figure below tries to explain how stagflation occurs using the supply shock factor (Tejvan "Stagflation”).
Price level AS2
P2 AS1
P1
Y2 Y1 AD
Real GDP (Y)
Policy makers usually have a challen...