Definition of Stagflation: Meanings and the İmportance
İn particularly, we saw in the early ’70s, in 1973, when the oil embargo hit that we started to experience something called stagflation or something that was labeled stagflation. İt’s this bizarre circumstance where you have inflationat the same time. İn particular, let’s think about how that would happen due to a supply shock. There’s other ways that you could get stagflation.
İf you have strange regulation or over regulation, the goverment does weird things. But the classic example is a supply shock. When we say supply shock, it’s like an oil embargo where all of sudden the supply oil or supply of something just goes down dramatically. And it could be because of some type of emergency. Just think about how that would affect the rest of this chain.
We know that supply has an inverse relationship with price. So if supply goes down, than there the price immediately go up. And when we think about something like oil, you might say, oil is only the part of my pocketbook where I drive around. But that is wrong! Even you buy a fruit, you are really paying the transportation cost. So the price of oil affects fruit, affects food or affects any good in services. İt’s one of these things that’s pervasive through the economy. So the prices of a bunch of things could generally go up. İf the price of a bunch of things generally go up, what’s going on the demand?
Once again, inverse relationship right over here, demand is going to plumment. İf demand plumment, utilization plumments, investment plumments and profit is going to plumment. And also profit is going to plumment now because utilization is going down and price has gone up. But it’s not the price that they can sell things. Now price is fundamentally a big cost for especially if you think of it from US-centric point of view. İf oil is an important, as in the case of the early ‘70s, then price is going up. I guess they have an inverse relationship. So the price goes up. İt’s really going to be on the cost side. And it all of these things go down, that’s just going to kill employment, kill wages and then further make demand even worse. So stagflation is that situation where you have some type f shock to the system, where in the classic scenario it hits supply so hard it causes a massive inflation in one part of the economy and as the case of oil, a part that affects other parts of the economy.