Stagflation

Hat is stagflation, or what are the causes of stagflation? Stagflation is a term that refers to a period in the economy when a country faces a recession simultaneously with an inflationary condition. The term therefore represents the two phenomena – stagnation, and inflation.

Keynesian theory regarding stagflation in economy

Recession means reduced access to credit and less consumption by people and companies, providing an increase in supply in relation to demand. However, there are cases that are outside the norm, in which prices of goods and services continue to rise when an economy slows down. In this scenario, we have an important increase of two elements – that of inflation itself and unemployment.

All stagflation comes from an unbridled expansion of credit granted by a country’s banks. The Keynesian theory of the market says that, in order to stimulate an economy to grow, credit supply must be favoured, because through “aggregate demand” is that companies return to invest and generate jobs. What happens is that the policy of easy and cheap credit cannot last forever; it always causes an increase in the monetary base. One of the primary effects of stagflation.

In this way, the shares start trading at a great discount

As this credit is by no means backed by savings, and the Central Bank will eventually need to raise the interest rate to control inflation (increases in the monetary base, devalue a country’s currency, as there will now be much more supply of it), this increase in the interest rate means that the various companies and people now need to refinance their debts. However, at that moment with much higher rates than it was on a previous occasion. All this situation of attempting to survive through more credit to refinance debts, can lead to bankruptcy of companies, and unemployment for workers, especially those linked to sectors of capital goods, as they are the ones that generally more depend on credit and a favourable economic situation to be able to make sales. Periods like those of stagflation in India bring great pessimism towards the economy. This pessimism can often be exaggerated.

Conclusion: Meaning of stagflation in the economy

Stagflation in the economy corresponds to a situation of recession, with a decrease in economic activities, and the level of employment. As a rule, lower economic growth results in lower growth in goods. However, when there are structural problems in the supply, there may be a decrease in economic growth and an increase in prices, with what is called stagflation.