Stagflation is an economic environment characterised by slowing economic growth and rising inflation. In fact, the term “stagflation” is derived from the words “stagnation” and “inflation”.

Stagflation as Real-Life Example

The 1970s is a famous stagflationary period and although there isn’t a single correct answer, economists identified two possible explanations for why it occurred. The first reason can be a supply shock like rapid increase in oil prices.

This situation also increases production costs and at the same time slows economic growth as everything becomes more costly eroding purchasing power.

In the 1973 the Organisation of Petroleum Exporting Countries (OPEC) placed an embargo on Western countries which caused oil prices to spike, making everything more expensive.

The second reason is attributed to wrong government policies that harm the economy while expanding the money supply. This can create a shortage in goods or services accompanied by rising demand from higher supply of money that ultimately leads to rising prices.

Stagflation is known to be hard to eradicate. In fact, from the 1979 to 1983, the Federal Reserve Chairman Paul Volcker increased interest rates very sharply in order to stop inflation, but the price to pay was high as that ultimately lead the US economy into a recession.