IAS Economy Practice Question . 14

Consider the following:
1. High growth rate
2. High unemployment
3. High Inflation
Which among the above is/ are features of “stagflation” ?
[A]1 & 2
[B]2 & 3
[C]1, 2 & 3
[D]1 & 3

Answer: 2 & 3
Stagflation is an economic situation where the growth rate slows down, unemployment levels remain steadily high & inflation also stays high. Stagflation, a concept which did not gain acceptance till the 1960s, is described as a situation in the economy where the growth rate slows down, the level of unemployment remains steadily high and yet the inflation or price level remains high at the same time. At the first instance, high inflation and unemployment or slower growth seem like opposites and mutually exclusive. It came to be seen in the 1970s as a situation when the economy has low productivity and yet the goods are highly priced in spite of low unemployment. The term ‘stagflation’ came to be used for the first time in the British Parliament by Lain Macleod in 1965. Once stagflation occurs it is difficult to deal with. The measure a government usually takes to revive an economy in recession (cutting interest rates or increasing government spending) also increases inflation. Under normal recessionary conditions, inflationary policies are acceptable, but here, given the already high inflation, pushing inflation still higher could mean prices spiraling out of control, thus further hitting productivity and growth.The major reasons for stagflation, whenever it has occurred in history, have been-supply shocks or shortages due to unforeseen reasons which push up prices of essential commodities, causing an inflationary situation and at the same time pushing up production costs, as it happened in 1970s in the US. The other reason is failure of the monetary authority to control excessive growth of money supply in the economy and excessive regulation of goods and labour markets by the government. For example, in the 1970s, a similar situation occurred during the global stagflation, where it began with a huge rise in oil prices, but then continued as central banks used simulative monetary policy to counteract the resulting recession, causing a runaway wage-price spiral.

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