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What is stagflation and how can it happen again?

15 December 2016

Most countries have faced the difficulty of recession. Australia has experienced two great recessions in our somewhat short history; at the beginning of the 1930s and more recently in the 1990s after a major stock collapse. But one of the most notable and puzzling trends to have rocked the developed world occurred in the 1970s. Through a number of factors that no one seemed to fully predict, we entered what was flagged as stagflation—a wordplay that describes the economy as stagnant in growth, yet experiencing high inflation.

Before the 1970s stagflation era, one economic trend had been considered fairly bullet-proof: that is, if the economy is faltering or slumping, businesses can save costs by making staff redundant, in turn creating high unemployment rates. However, without jobs, people don’t have as much money to spend, and as part of the consumer demand model, prices have to decrease to keep business churning. So, when a recession is occurring, inflation should not be.

Here lies the key difference and danger between a typical recession and stagflation; while the economy was tanking in the ‘70s and unemployment rates were skyrocketing, inflation was also steadily on the climb.

How did stagflation happen?

There were two main factors that contributed to this unusual crisis. After the Second World War, there was an economic boom in many western countries. Unemployment was incredibly low, meaning natural inflation began to occur at a steady rate.

Noting the inflation, employees expected their wages to be increased accordingly. At first, this was fine, until businesses could no longer keep providing pay rises at the same rate as inflation. Not willing to work for wages that weren’t comparable to the affluent market, unemployment began to grow.

Then there’s the second factor; the 1973 oil crisis. The Organization of Arab Petroleum Exporting Countries (OAPEC) introduced an oil embargo, driving petrol prices up dramatically. Rising oil prices don’t just affect citizens at the petrol pump; they have a domino effect across various industries.

Inflation was now reaching its peak, as was the unemployment rate. With a high majority of consumers jobless, they were unable to inject any money into the economy, especially with prices being exorbitantly high.

Can it happen again?

Since its resolution, very few people have predicted another stagflation, and so far those hypotheses have remained the same. Most economists dismiss the likelihood of Australia re-entering stagflation, not only because it was a unique combination of events that caused it in the first place, but also because of what we’ve learned from it.

Governments and economists are now more diligent in monitoring inflation levels, particularly in times of recession. They are also continually improving on predicting economic trends, in order to maintain the intricate balance of having the right amount of money in circulation.

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