STAGFLATION

STAGFLATION is a term referring to transitional periods when the economy is simultaneously experiencing the twin evils of inflation and high unemployment, a condition many economists as late as the 1950s considered a typical of the U.S. economy. Stagflation occurs when the economy is moving from an inflationary period (increasing prices, but low unemployment) to a recessionary one (decreasing or stagnant prices and increasing unemployment). It is caused by an overheated economy. In periods of moderate inflation, the usual reaction of business is to increase production to capture the benefits of the higher prices. But if the economy becomes overheated so that price increases are unusually large and are the result of increases in wages and/or the costs of machinery, credit, or natural resources, the reaction of business firms is to produce less and charge higher prices.

The term first came into use in the mid-1970s, when inflation soared to 12 percent and the unemployment rate nearly doubled to 9 percent. This inflation was the result of the quadrupling of oil prices by the Organization of Petroleum Exporting Countries (OPEC), increases in the price of raw materials, and the lifting of Vietnam-era government-imposed price and wage controls. At the same time, the economy went into recession. In 1979 the high inflation rate was sent spiraling upward when OPEC doubled petroleum prices after the Iranian revolution. President Jimmy Carter established the Council on Wage and Price Stability, which sought voluntary cooperation from workers and manufacturers to hold down wage and price increases. The council could not control OPEC, however, and repeated oil-price hikes thwarted the council's efforts. Years of continued inflation and high unemployment was one of the factors that undermined the Carter presidency and Democratic Party proposals for welfare reform, national health insurance, and reform of labor law.

In 1980, after years of double-digit inflation the Federal Reserve Board (Fed), under Paul Volcker, prodded banks to raise interest rates to record levels of more than 20 percent to induce a recession and break the inflation cycle. Subsequently the Fed pursued a monetary policy designed to head off significant increases in inflation, but in 1994–1995, seven Fed increases in short-term interest rates failed to moderate economic growth. This led to speculation that in a global economy, domestic monetary policy may not be as effective in controlling stagflation as previously thought.

BIBLIOGRAPHY

Ferguson, Thomas, and Joel Rogers, eds. The Hidden Election: Politics and Economics in the 1980 Presidential Campaign. New York: Pantheon Books, 1981.

Greider, William. Secrets of the Temple: How the Federal Reserve Runs the Country. New York: Simon and Schuster, 1987.

Lal, Deepak, and Martin Wolf, eds. Stagflation, Savings, and the State: Perspectives on the Global Economy. New York: Oxford University Press, 1986.

Weintraub, Sidney, and Marwin Goodstein, eds. Reaganomics in the Stagflation Economy. Philadelphia: University of Pennsylvania Press, 1983.

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See alsoBanking: Overview ; Federal Reserve System ; Oil Crises .