What is stagflation?

Stagflation is defined as an economy that is suffering both an increase in inflation and a standstill in economic production at the same time. Stagflation was initially identified in the 1970s, when an oil shock caused fast inflation and significant unemployment in many industrialized nations. The prevailing economic theory at the time could not clearly explain how stagflation might develop. Price increases during periods of weak or negative economic development have been the rule rather than the exception since the 1970s.

Stagflation can be defined as situation in an economy which is characterised by high inflation and high unemployment both occurring contemporarily.

Causes of Stagflation:

  1. When the productive capacity of an economy is reduced by an unfavourable supply shock. For example, an increase in the price of oil for an oil importing country.Such supply shock tends to raise prices and weakens the economy by making production more costly and less profitable.
  2. Stagflation can also be caused by Macroeconomic policies that are designed to regulate money supply in the economy or try to regulate the labour market.