The 1970s economy was prone to stagflation due to its dependence on commodities. Today’s economy is affected by disruptions in supply chains, robust consumer activity, and high inflation. However, today’s economic conditions do not seem to warrant stagflation, at least in the near future. Despite the recent inflationary spike, the economy is healthy and growing, and the high level of excess savings suggests that the economy will continue to grow heartily in the next few quarters.
Theories of stagflation
The Lucas Critique attempts to blame Keynesian policy-advisers for stagflation, and argues that the government and FED pushed inflation and the real wage higher by implementing expansive policy in the 1960s. In response, private agents adapted their behavior and expectations in order to benefit from the new policy regime. As a result, monetary policy became ineffective, and expectations rose.
The demand-pull stagflation theory, first developed by economist Eduardo Loyo, asserts that stagflation can result from monetary shocks, such as monetary tightening regulations by government agencies. On the other hand, the cost-push inflation theory focuses on supply-side inflation, where higher prices reduce profit margins and decrease economic output. This spiral continues regardless of the unemployment rate.
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Factors that lead to stagflation
The monetary explanation for stagflation is appealing, but it isn’t complete. It cannot explain the simultaneous increase in prices and the decrease in unemployment. In addition, the economic policy of former President Richard Nixon, who froze prices and wages for 90 days, led to stagflation in the 1970s. But these are just a few of the many factors that cause stagflation.
One of the most important causes of inflation is a high price for oil. Many goods are produced with oil, and rising prices mean that the cost of transportation is higher than the cost of production. As a result, many producers reduce production, reducing the overall supply of goods and services. This decrease in production, along with rising costs, will inevitably lead to higher overall prices. In the long run, this situation is unlikely to lead to stagflation in the United States, although it will likely increase unemployment.
Catalysts for stagflation
The emergence of a pandemic virus such as Covid-19 has the potential to trigger a longer period of “stagflation.” This would undermine the efforts of governments to combat the outbreak and force growth to return to pre-pandemic levels. In 1990, the global economy thrived during the “Great Moderation,” a period of moderate growth and low inflation. However, governments’ policies in the 1970s and 80s made this situation more likely.
In 1973, the Organization of Petroleum Exporting Countries (OPEC) embargo caused price spikes and production cuts that pushed inflation and unemployment higher. By 1974, the price of oil per barrel had more than doubled and eventually quadrupled. Stagflation continued to weigh heavily on the US economy throughout the 1970s, and the OPEC oil embargo did little to alleviate the problem.
Impact of stagflation on the economy
Whether the United States will suffer from stagflation is an important question to ask. The stock market has experienced a period of correction as geopolitical uncertainty from Russia’s invasion of Ukraine led to higher fuel prices. And fund managers have been holding more cash today than they did in April 2020, the month before stagflation became a big concern. This economic phenomenon could further worsen an already fragile economy and cause further contraction. Investors, therefore, need to consider investing in stocks that have a high probability of weathering the recession.
The main reason stagflation affects the economy is because the price of basic goods goes up and down simultaneously. The monetary explanation for this phenomenon is appealing, but it cannot explain the simultaneous rise in prices and low unemployment. In the case of the United States, a price increase in food and energy prices coincided with a fall in unemployment. In this case, the two economic phenomena are inextricably related.
Impact of stagflation on the misery index
In the 1970s, a country’s misery index was the highest it has ever been. The measure of economic distress was created by economists and is based on the addition of the inflation rate and the seasonally adjusted employment rate. It is a way to measure economic distress and is used to gauge economic growth. During the first two decades of President Ronald Reagan’s administration, Japan experienced the highest misery index.
The misery index is an economic measure that measures the level of citizen misery. The index includes inflation, unemployment, and other economic indicators such as the rate of bank lending. Although this measure is convenient, it is also imprecise and may not adequately reflect economic distress under certain circumstances. As a result, the index has become a popular gauge of national economies. This article will explore how stagflation can affect the misery index.