Peter Decaprio- Explains stagflation and how it relates to the business cycle.

In economics, stagflation refers to a situation in which the inflation rate of an economy is high, economic growth stagnates and unemployment remains steadily high. Where inflation rises but economic growth slows down or stagnates and unemployment is high explains Peter Decaprio. Since these three factors – inflation, stagnation and unemployment – tend to move together at the same time it is often referred as “stagflation.”

Stagflation can occur if:

1) The country’s productive capacity has not kept pace with demand causing over-utilization of production inputs such labor and raw materials;

2) A decrease in aggregate supply caused by reduced productivity;

3) Demand decreases due to tighter monetary policy (less money chasing fewer goods).

The term was first coined during the 1973 oil crisis. In 1979, the UK had been suffering from stagnant growth combined with inflation that reached nearly 25 percent, which was close to five times higher than what the government deemed acceptable.

Stagflation is typically caused by a combination of factors (i.e., not one specific factor). Stagflation can be either demand-pull or cost-push inflation.

1) Demand-pull inflation occurs when aggregate demand exceeds productive capacity;

2) Cost-push inflation occurs when costs are increasing in all stages of production (i.e., during both production and distribution);

3) If both causes occur simultaneously it is ‘second generation’ stagflation;

4) Third-generation stagflation occurs when cost-push inflation is combine with demand-pull inflation.

A business cycle refers to the general economic pattern of expansion, followed by contraction and then followed by expansion again which pervades an economy over time. Periods of expansion are called “growth” or “boom,” while periods of contraction are called “recession” or “bust”.

During a recession, unemployment and capacity utilization decline, and companies produce less – leading to price deflation (i.e., lower prices).

When an economy is going through a period of growth it means there is an increase in money supply (since more transactions take place), interest rates fall and stock prices go up; everything points towards higher inflationary pressures says Peter Decaprio.

A theory on how stagflation occurs is the Phillips Curve which states that if the unemployment rate falls too low, inflation will go up. This occurs because a tighter labor market leads to wage-price spiraling as companies try to protect their profits by pushing up prices and/or increasing wages.

Inflation defines as an increase in the general price level of goods and services over a specific period of time. Inflation can be measure by looking at changes in consumer prices, producer prices or commodity prices.

The Causes of Inflation are:

1) Demand-pull inflation occurs when aggregate demand exceeds productive capacity;

2) Cost-push inflation occurs when costs are increasing in all stages of production (i.e., during both production and distribution);

3) If both causes occur simultaneously it is called ‘second generation’ stagflation;

4) Third-generation stagflation occurs when cost-push inflation is combine with demand-pull inflation. Drastic changes in the value of currency also cause inflation. So an increase in the money supply may not always lead to inflation. This depends on exchange rates and how much the currency has changed.

Stagflation can be cause by a decline in aggregate supply. Due to either productivity or oil price shocks (i.e., petroleum exporting countries restrict their exports which leads to less supply).

If there is little spare capacity left then it means that companies are already running at maximum output. Thus producing more without any changes will cause prices to rise (since producers will pass on costs).

The only way for the government to contain high inflation is to cut aggregate demand and/or implement fiscal and monetary policies explains Peter Decaprio. Fiscal policy refers to government action which involves changing tax levels or expenditure levels; while, monetary policy involves the control of money supply in an economy (i.e., interest rates).

Stagflation is a term that generally refers to the combination of high unemployment and rising inflation. An undesirable situation for most industrialized countries. It can be as a result of the Phillips curve. Which low unemployment rates are correlate with higher inflation rates.

Generally, stagflation occurs during periods of economic downturn or stagnation. This suggests that while there may be fluctuating levels of inflation within the business cycle. This phenomenon only belongs to periods outside regular growth, such as recessions.

The cited article summarizes by saying “in order to describe this unusual state officially. It was necessary to find a new word; hence ‘stagflation’.” This statement makes sense. Because nothing like this occurred before in any other business cycle, thus creating a new term.

Conclusion:

Stagflation is a combination of high unemployment and rising prices. Which can occur during periods of economic downturn or stagnation says Peter Decaprio. To describe such an unusual condition officially, new words were invent; hence ‘stagflation.’

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