Stagflation is a combination of the words “stagnant” and “inflation.”
Stagflation is defined as an economic scenario with high inflation rates, low economic growth, and often characterized by high unemployment rates.
Stagflation can pose a quandary for governments because most actions aimed at lowering inflation like raising of interest rates may cause hardship to existing businesses, lower consumption and lead to further economic slowdown. While policies aimed at boosting economic growth and lowering unemployment like lowering of interest rates may actually worsen the inflation scenario.
What causes Stagflation?
While it may be difficult to state the exact reasons which cause stagflation, poor economic policies or the supply deficit of an essential input commodity could be a significant contributing factor.
For example, an unprecedented shortfall in global oil supply could cause oil prices to skyrocket. For an economy that relies on oil imports, this would result in a sharp increase in the price of goods on the domestic market, reducing household consumption. These factors may combine to render many businesses unviable, resulting in an economic downturn.