Stagflation is an economic trend in which inflation and unemployment rise while general growth of the economy is slow.Term ‘Stagflation’ is developed by combining words ‘stagnation’ (slow economic growth for a longer period) and Inflation to denote the situation in which economic growth stagnate while inflation contradictorily increases. Many governments try to avoid stagflation, by promoting even and healthy growth and attempting to prevent inflation, since it triggers economic recession. Why stagflation occurs? There are two different situations in which it occurs. Firstly, stagflation can result when an economy is slowed by an unfavorable supply shock, such as an increase in the price of oil in the oil importing country, which tends to raise prices at the same time that it slows the economy by making production less profitable. Secondly, it emerges from inappropriate economic policy. For example, central bank can cause inflation by allowing excessive money supply, and the government can cause stagnation by exerting control measures on markets of goods and labor, together, these factors can cause stagflation. It can be difficult to correct stagflation, because focusing on actions of fighting inflation worsen economic stagnation and vice versa, a real typical dilemma for policymakers. It represents a unique and serious economic issue.
Stagflation occurred in several countries in the 1970s, due to oil crisis। High oil prices contributed to general inflation while employment and the domestic economy remained sluggish. Central banks of some nations were ultimately forced to intervene and freeze the money supply and thus trigger a recession, but ultimately the economies stabilized, with the unemployment rate naturally self-correcting while inflation went down. Consumers may suffer greatly during stagflation, as they find goods and services too expensive to afford, while they cannot obtain jobs to pay for basic needs. Since the government may restrict the availability of loans in an attempt to combat stagflation, consumers may have to drastically cut their budgets to survive.
Here, it is important to understand ‘stagnation’। It is basically a structural shortage of money with those who generate the type of demand that is the major drivers of economies - lower and middle class consumers, and governments. Structural gap arises between productive capacity and purchasing power of these classes derived from actual income and not borrowing. On the one hand, due to technological development, production capacity keeps rising. On the other, lower and middle income groups see stagnation in real incomes, due to a downward pressure on wages caused by increasing national and international competition and the increased mobility of business. To a certain extent, the downward pressure on wages can be compensated by working more hours. Heavy bank loans and earnings in stock markets also allow demand to keep up with production capacity. However, there are limits to the number of hours people can work, the amount of money they can borrow, and the extent to which the stock market can rise. As these limits are being reached, the structural imbalance between production capacity and demand becomes clear. With demand remaining stagnant or decreasing, business is pushed to operate more efficiently by raising productivity and laying off employees. Thus, the gap between productive capacity and purchasing power increases further. Likewise, demand from governments stagnates because, in the drive to lower taxes, government income stagnates or decreases. The situation worsens as the economy slows. Tax income is reduced and social security payments increase, leaving governments with less money to spend on goods and services. That contributes to the further growth of the gap between productive capacity and purchasing power.
All these so called solutions hardly work as they do not address the fundamental problem in the global economy: the lack of purchasing power. The credit of economic growth during last two decades is generally attributed to economic globalization, increasing international trade. It is believed that freeing trade and capital flows, increases competition and allows capital to flow there where it can be used most productively. That increases productivity and efficiency, leading to better quality products and services for lower prices. It also allows new investments and consumption, which further fuels the economy. But this is partly true. Consumers do benefit from competition between producers leading to greater choice, lower prices and better quality. However, no account is taken of the fact that before consumers can buy products they have to earn the money to do so. And that’s where the problem lies. Plea that globalization is a driving force of world economy does not hold anymore with the onset of current recession. In spite of increasing liberalization and growing trade, the economy has slumped. And as most economists will confirm: the main problem is sluggish demand.
Question now arises as to how demand can be increased. Following are the options:
1. Reducing interest rates,
2. Free trade regime
3. and reducing taxes.
However, none have been independently proved effective so far because as said earlier, they do not address the fundamental problem of Lack of Demand from lower and middle income class of people who majorly drive economic growth. Free Trade is good for consumers’ interests, but not for raising demand. Tax Cuts which most benefit upper class or higher middles class does not increase spending and therefore overall demand. Yes, to some extent, tax cuts benefiting this class is supposed to increase investment that creates jobs, earnings and therefore, demand. But, what happens in practice is that the money flowing to rich individuals and corporations is used not so much for productive investment as for speculation; look at the rise in stock markets and the mega-mergers and take-over of the last two decades. Money is sucked out of the "real", productive economy and drawn into a virtual economy that is based on speculation. It is because Profits to be made in that virtual economy are often much higher, or perceived to be much higher, than those of the "real" economy. Even speculation is not a problem as long as stock market is rising because it increases wealth and purchasing or investing power of rich people. However, these effects are temporary: unavoidably each speculative bubble will, at some point, burst. The result of such a collapse is that enormous amounts of capital are destroyed: as stock prices tumble, the corresponding wealth simply vanishes into thin air.
On the other hand, in a stagnant economy the rich are likely to put their additional wealth in financial safe heavens such as gold or real estate. On the other hand Tax cuts are likely to lead a decrease in government consumption and investment, which reduces demand. The problem is, as it is, difficult and seems to have become more obscure in growing economies. Lower and middle class consumers have masked their void of purchasing power by heavy borrowings, but spending more than you earn does not always go well. Even the upper class has multiplied its asset value, but mostly by means of speculation which is bubble that can burst anytime. Free Trade has, inter alia its benefits, the risks of unreasonable concentration of wealth in the hands of few where it is least needed and downward pressure on wages due to international competition. In short, situation is not anyway inspiring one for sustainable development.
It is largely opportune to keep money in the real economy, where it can generate demand among lower and middle income groups and governments. Major public investment is needed in such fields as the reduction of energy use and pollution, protection of natural environments, and sustainable land and water management, public education, health care, safety and infra-structure. Ideally, Government should raise funds for these expenses by increasing taxes. But, tax increase may weaken the industry’s competitive strength in global trade. Besides, politicians don’t like to raise taxes because often even a minor hike is political suicide. Be it a recession or any other public detriment, everybody now realizes that the lack of regulation is the main cause of all the bad effects arising from different theories or remedy options. Nobody would deny that the politicians are paid to deregulate. They are accepting enormous campaign contributions from corporations, banks, hedge funds and financial institutions. Why it is often criticized that bailouts are declared to support influential class which is actually responsible for recession? It is so because, politicians may bargain highest package in return at future point of time. Even within politics, republicans would never want that Obama succeeds in his regime to combat recession. The Great Depression 1929 is a recorded history. So, this is the name of the Game. The politicians, self-centered idiots, know it well to protect their interest, but they truly do not know that meltdown is the cause of their monstrous deeds. In addition to this, mainstream media try to horrify the situation announcing that bailout of $700 billion is not enough? Have they ever warned governments or even people about the possibility of stock market decline, inflation or credit crisis?
To be true and honest, Bailout is nothing but an attempt of flogging a dead horse and that too is mostly driven by political motives. Using long, drawn-out processes to put money into circulation to meet an emergency is like mailing a letter to the fire department to tell them that your house is on fire.
Here is one comic example about it……………………………।
Friends were chatting leisurely at coffee counter in New York.
“The federal government is sending each of us a $600 rebate.
If we spend that money at Wal-Mart, the money will go to China.
If we spend it on gasoline it will go to the Arabs,
If we purchase a computer it will go to India,
If we purchase fruit and vegetables it will go to Mexico, Honduras, and Guatemala,
If we purchase a good car it will go to Japan,
If we purchase useless crap it will go to Taiwan…
…..………………. This is the ground reality of US economy…The only way to keep that money at home is to buy prostitutes, beer and cigarettes, since these are the only products still produced in the US.”
All and all, even if the situation improves and demand picks up somehow, there are more problems ahead. Enormous debts of the government run up in attempts to boost the economy may evolve in a major economic and financial crisis. Then there is the indebtedness of the United States that like Japan can lead to a major financial and economic crisis. For several decades, an important part of the growth in the US has been financed by foreigners: through direct investment in the United States, buying U.S. securities, and purchasing dollars. The corresponding inflow of money has allowed Americans – consumers, companies, government - to spend more than they earn. Every month imports exceed exports by tens of billions of dollars, and each year itself seems to bring new highs in the gap between the two. Today, USA is the biggest debtor of the world; some economists say its’ bankrupt. If for some reason dollar sinks in value and inflow of money stops coming to US, it would be a grinding halt for world economy . Ironically, US government default is no more unthinkable in the present situation.
Third, in the longer run, graying populations in Europe, Japan and US will demand such increases in pension payments which public and to a lesser extent, private pension funds will be unable to pay out.. The outlook is especially worrisome for countries where pensions are paid from current accounts rather than savings. For some countries, it has been estimated that by 2020, three working people will have to "maintain" one retiree – as against today’s five or six. To fulfill its obligations towards pensioners, governments will have to reduce pensions, cut public investment and borrow heavily. All these measures will have a depressing effect on demand and thus, overall economy. So what must be done to reboot the economies of the rich nations, and avoid the economic crises that may be in store in the coming twenty years? Answer lies in generating extra demand for goods and services through a large-scale public investment program aimed at converting to a socially equitable and environmentally sustainable society. That can be done by accumulating money through cost-cuttings, progressive taxation, IMF etc. Apart from these, there are many imminent problems facing world economy. Premature celebration of economic recovery followed by meager improvement would lead to utter disappointment.
Where did you reach at the end of day? You returned to a place from where you had started traversing the way in the morning. Sheer Nullity!
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