Guide Note

Stagflation is an economic term coined in the 1960s and formed from a combination of the words "stagnation" and "inflation." An economy is in a period of stagflation when slow economic growth occurs along with sharp price increases.

Fast Facts

1. Combination of word "stagnation" and "inflation"
2. Global economy went through stagflation period in 1970s
3. Economists debate whether global economy entered period of stagflation in 2007
4. Stagflation in 1970s caused by rise in price of oil
5. Oil price increases cause inflation, as price of transporting goods increases

In an economic downturn, classic economics theory holds that lowering interest rates will enable consumers to borrow more cheaply in order to purchase goods and services. This interest rate lowering should, in theory, encourage spending and help revive the economy. However, lowering interest rates also raises the potential of creating inflation, making it more difficult for consumers to purchase those same goods and services the lowering of the interest rates is designed to help them afford. The corresponding dilemma is that economic measures that are taken to reduce inflation, such as price and wage controls, often result in a weakening of the general economy. In a stagflation scenario, the central bank becomes somewhat powerless, as any action that is taken will result in one of two undesirable outcomes.