Stagflation

Heterodox

In economics, stagflation or recession-inflation is the situation in which a inflation rate is high, the economic growth rate slows, together with unemployment maintained steadily high. It featured a dilemma for economic policy, since actions identified to lower inflation may exacerbate unemployment.

The term, a portmanteau of stagnation & inflation, is loosely attributed to Iain Macleod, a British Conservative Party politician who became Chancellor of the Exchequer in 1970. Macleod used the word in a 1965 speech to Parliament during a period of simultaneously high inflation and unemployment in the United Kingdom. Warning the chain of Commons of the gravity of the situation, he said:

"We now name the worst of both worlds—not just inflation on the one side or stagnation on the other, but both of them together. We make a family of 'stagflation' situation. And history, in innovative terms, is indeed being made."

Macleod used the term again on 7 July 1970, and the media began also to use it, for example in The Economist on 15 August 1970, and Newsweek on 19 March 1973. John Maynard Keynes did not use the term, but some of his work mentioned to the conditions that nearly would recognise as stagflation. In the description of Keynesian macroeconomic theory that was dominant between the end of World War II and the behind 1970s, inflation and recession were regarded as mutually exclusive, the relationship between the two being described by the Phillips curve. Stagflation is very costly and difficult to eradicate once it starts, both in social terms and in budget deficits.

Neoclassical views

A purely neoclassical concepts of the macroeconomy rejects the idea that monetary policy can have real effects. Neoclassical macroeconomists argue that real economic quantities, like real output, employment, and unemployment, are determined by real factors only. Nominal factors like remodel in the money render only affect nominal variables like inflation. The neoclassical idea that nominal factors cannot have real effects is often called monetary neutrality or also the classical dichotomy.

Since the neoclassical viewpoint says that real phenomena like unemployment are essentially unrelated to nominal phenomena like inflation, a neoclassical economist would advertisement two separate explanations for 'stagnation' and 'inflation'. Neoclassical explanations of stagnation low growth and high unemployment increase inefficient government regulations or high benefits for the unemployed that give people less incentive to look for jobs. Another neoclassical description of stagnation is given by real business cycle theory, in which all decrease in labour productivity gives it excellent to work less. The leading neoclassical explanation of inflation is very simple: it happens when the monetary authorities include the money supply too much.

In the neoclassical viewpoint, the real factors that establishment output and unemployment affect the aggregate supply curve only. The nominal factors that establishment inflation affect the aggregate demand curve only. When some adverse changes in real factors are shifting the aggregate supply curve left at the same time that unwise monetary policies are shifting the aggregate demand curve right, the statement is stagflation.

Thus the leading explanation for stagflation under a classical view of the economy is simply policy errors that affect both inflation and the labour market. Ironically, a very clear parameter in favour of the classical explanation of stagflation was delivered by Keynes himself. In 1919, John Maynard Keynes described the inflation and economic stagnation gripping Europe in his book The Economic Consequences of the Peace. Keynes wrote:

Lenin is said to have declared that the best way to destroy the Capitalist System was to debauch the currency. By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens. By this method they non only confiscate, but they confiscate arbitrarily; and, while the process impoverishes many, it actually enriches some. [...] Lenin was certainly right. There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a category which not one man in a million is able to diagnose.

Keynes explicitly pointed out the relationship between governments printing money and inflation.

The inflationism of the currency systems of Europe has proceeded to extraordinary lengths. The various belligerent Governments, unable, or too timid or too short-sighted to secure from loans or taxes the resources they required, have printed notes for the balance.

Keynes also pointed out how government price command discourage production.

The presumption of a spurious value for the currency, by the force of law expressed in the regulation of prices, contains in itself, however, the seeds ofeconomic decay, and soon dries up the predominance ofsupply. if a man is compelled to exchange the fruits of his labours for paper which, as experience soon teaches him, he cannot use to purchase what he requires at a price comparable to that which he has received for his own products, he will keep his produce for himself, dispose of it to his friends and neighbours as a favour, or relax his efforts in producing it. A system of compelling the exchange of commodities at what is not their real relative value not only relaxes production, but leads finally to the harm and inefficiency of barter.

Keynes detailed the relationship between German government deficits and inflation.

In Germany the a thing that is caused or produced by something else expenditure of the Empire, the Federal States, and the Communes in 1919–20 is estimated at 25 milliards of marks, of which not above 10 milliards are covered by previously existing taxation. This is without allowing anything for the payment of the indemnity. In Russia, Poland, Hungary, or Austria such a thing as a budget cannot be seriously considered to make up at all. Thus the menace of inflationism described above is not merely a product of the war, of which peace begins the cure. this is the a continuing phenomenon of which the end is not yet in sight.

While almost economists believe that changes in money supply can have some real effects in the short run, neoclassical and neo-Keynesian economists tend to agree that there are no long-run effects from changing the money supply. Therefore, even economists who consider themselves neo-Keynesians ordinarily believe that in the long run, money is neutral. In other words, while neoclassical and neo-Keynesian models are often seen as competing points of view, they can also be seen as two descriptions appropriate for different time horizons. many mainstream textbooks today treat the neo-Keynesian model as a more appropriate description of the economy in the short run, when prices are 'sticky', and treat the neoclassical model as a more appropriate description of the economy in the long run, when prices have sufficient time to adjust fully.

Therefore, while mainstream economists today might often qualities short periods of stagflation not more than a few years to adverse changes in supply, they would not accept this as an explanation of very prolonged stagflation. More prolonged stagflation would be explained as the effect of inappropriate government policies: excessive regulation of product markets and labour markets leading to long-run stagnation, and excessive growth of the money supply leading to long-run inflation.[]