When inflation exceeds economic growth, this creates stagflation. It is an unusual and hard-to-predict combination of rising prices or inflation and a stagnant economy. It is not a common occurrence, but when it occurs, it comes with significant consequences for the economy. Is the gambling industry safe? One of the biggest concerns for casino executives is stagflation. While seemingly counterintuitive, many casinos – especially in parts of Europe – have been experiencing a decline in revenue over the years. In a stagflation environment, betting companies like the online casino NetBet put special deals for gamers in an attempt to mitigate inflation. The term stagflation came into vogue in the 1970s in Britain when the country was experiencing a prolonged economic downturn along with rising prices of commodities because of global inflationary pressures. However, stagflation can also be said to have originated in the United States during the Nixon administration, when GDP declined while unemployment and inflation surged.
What Causes Stagflation?
Stagflation occurs due to slower-than-expected growth in output coupled with a surge in inflationary pressures because of high demand for products and services when supply is low. If a country produces fewer goods, this results in higher prices due to a shortage in supply. Since there are fewer goods available, demand decreases, which means that fewer people will be employed. Check out the below theories:
Supply shock causes stagflation when prices of goods skyrocket, with the general price level in the economy rising. This causes demand to slump at higher prices and creates an inflationary gap. To fight inflation, interest rates will increase, causing output and employment to fall, as well as prices for goods by slowing output growth. So instead of the usual counter-cyclical response of increased employment and output during a recession, stagflation has a reverse effect of decreased employment and output during high inflation.
Poor Monetary Policy
Bad monetary policy can directly impact the supply curve, causing an increase in price and a decrease in output. Once this happens, there will be slower economic growth, hence, stagflation.
The main cause of stagflation is cost-push inflation. This occurs when a country’s supply costs increase, leading to higher prices. For example, if a country’s workers demand higher wages, or if there is an increase in the price of raw materials or oil, this increases the average cost of production. To prevent firms from going out of business, they need to pass on their increased costs to customers by increasing their prices. As a result, there is a rise in the general price level (inflation) and lower growth and employment (stagnation). In the short term, it can be difficult to distinguish between cost-push and demand-pull inflation. However, in the long run, we expect cost-push inflation to lead to rising unemployment.
The cause for stagflation is very complex and debated by economists. The most accepted theory is known as Differential Accumulation. It states that when you achieve a certain level of economic growth, it becomes increasingly difficult to continue growing at a similar rate. This is because you will eventually run out of resources, capital, or labour to fuel your economic growth at this rate. For example, if you want to double the output of your factory, you will need double the number of raw materials and equipment to do so.
Differential Accumulation can occur due to several factors:
- An increase in wages – As wages rise, businesses will have less money to spend on new equipment and staff, which reduces their ability to grow production.
- A decrease in the capital – As businesses grow, they become more reliant on borrowing money (capital) which can become more expensive.
Effects of Stagflation
- Enterprises go bankrupt due to the high-interest rate and decreasing demand.
- The unemployment rate increases, and the gap between rich and poor grows.
- Government spending rises, the budget deficit widens, and the national debt increases.
- The value of the national currency declines, causing a rise in inflation that makes imports more expensive.
- Job loss, lower wages, and deteriorated consumer confidence for the employed.
- Higher input prices lead to weaker sales and hence, lower profit margins.
What is the Remedy for Stagflation?
Manage stagflation at the bank level; When stagflation occurs, raise interest rates to encourage saving money instead of investing it. Lowering the money supply will lower inflation levels. You can also withdraw some of your money supply by raising government income taxes and lowering government spending. This slows down growth but helps bring inflation down.
Make changes in the business environment; One way to help businesses grow is to reduce taxes on small businesses in hopes of encouraging them to hire more employees and increase production. You can also lower taxes for consumers in hopes that they will go out and spend more money, which will help stimulate the economy and reduce unemployment rates.
Increase government spending during times of recession; This can help create jobs and increase production when people are not spending money or putting their savings into investments that are not growing because of high-interest rates. You can also temporarily lower interest rates to encourage borrowing and investing, which can stimulate the economy.
Most if not all governments have policies in place to tackle specific issues like stagflation. But the implementation of these policies is dependent on the economy and how well the solution fulfils its objectives.