Stagflation

A word built from stagnation and inflation, coined in British political debate in the nineteen sixties and attached permanently to the decade that followed it, when oil supply shocks arrived alongside already high inflation across the industrial economies. Its importance is that it broke the working assumption of the time, a stable trade off in which inflation and unemployment moved in opposite directions.

The mechanism is a supply shock. A demand shock moves output and prices in the same direction, so policy has an obvious lever. A supply shock, such as a sharp rise in the price of energy, raises prices while reducing output, so the two problems appear together. That is the dilemma: tightening policy to bring inflation down deepens the slowdown, and easing policy to support activity risks embedding the higher prices in expectations, after which they persist without the original shock.

Nobody declares a stagflation. There is no threshold, no agency that dates it and no agreed measure, so the word is applied by commentators using different evidence, and it is frequently reached for whenever inflation and weak growth coincide for a quarter or two. Economists also continue to disagree about how much of the original episode was the supply shocks and how much was the monetary policy that accommodated them, and that unresolved argument is precisely what people are arguing about whenever a modern episode is compared to it.