Stagflation is an economic event in which the inflation rate is high, the economic growth rate is low, and the unemployment rate is high.
Stagflation is a term used to describe an economy that is stagnant and experiences little to no economic growth.
Stagflation is a period in time when there is a combination of high inflation and economic stagnation.
In essence, it is characterized by rising unemployment and declining business production while the prices of goods and services get higher.
Both stagnation and inflation magnify each other, causing economic conditions to worsen further.
One of the worst things that can occur to a currency is the effect of stagflation.
It leaves very little room for central banks to move because it cannot raise interest rates enough to combat rising prices.
When prices rise disproportionately to interest rates, the value of the domestic currency depresses.
This, in turn, reduces the purchasing power of consumers.
As such, foreign exchange markets usually see stagflation as negative for the domestic currency.
What causes stagflation?
There is no consensus among economists on the causes of stagflation. However, two main theories may be derived: supply shock and poor economic policies.
The supply shock theory suggests that stagflation occurs when an economy faces a sudden increase or decrease in the supply of a commodity or service (supply shock), such as a rapid increase in the price of oil.
In such a situation, prices surge, making production costlier and less profitable, thus slowing economic growth.
A second theory states that stagflation can be a result of a poorly made economic policy.
For example, the government can create a policy that harms industries while growing the money supply too quickly.
The simultaneous occurrence of these policies can lead to slower economic growth and higher inflation.