STAGFLATION Stagflation is a term referring to transitional periods when the economy is simultaneously experiencing the twin evils of Inflation

and high Unemployment, a condition many economists as late as the 1950s considered a typical of the U.S. economy. Stagflation occurs when the economy is moving from an inflationary period (increasing prices, but low unemployment) to a recessionary one (decreasing or stagnant prices and increasing unemployment). It is caused by an overheated economy. In periods of moderate inflation, the usual reaction of business is to increase production to capture the benefits of the higher prices. But if the economy becomes overheated so that price increases are unusually large and are the result of increases in wages and/or the costs of machinery, credit, or natural resources, the reaction of business firms is to produce less and charge higher prices. The term first came into use in the mid-1970s, when inflation soared to 12 percent and the unemployment rate nearly doubled to 9 percent. This inflation was the result of the quadrupling of oil prices by the Organization of Petroleum Exporting Countries (OPEC), increases in the price of raw materials, and the lifting of Vietnam-era governmentimposed Price and Wage Controls. At the same time, the economy went into recession. In 1979 the high inflation rate was sent spiraling upward when OPEC doubled petroleum prices after the Iranian revolution. President Jimmy Carter established the Council on Wage and Price Stability, which sought voluntary cooperation from workers and manufacturers to hold down wage and price increases. The council could not control OPEC, however, and repeated oil-price hikes thwarted the council's efforts. Years of continued inflation and high unemployment was one of the factors that undermined the Carter presidency and Democratic Party proposals for welfare reform, national health insurance, and reform of labor law. In 1980, after years of double-digit inflation the Federal Reserve Board (Fed), under Paul Volcker, prodded banks to raise interest rates to record levels of more than 20 percent to induce a recession and break the inflation cycle. Subsequently the Fed pursued a monetary policy designed to head off significant increases in inflation, but in 19941995, seven Fed increases in short-term interest rates failed to moderate economic growth. This led to speculation that in a global economy, domestic monetary policy may not be as effective in controlling stagflation as previously thought. This term was widely used in the 1970s to describe the co-existence of stagnant economic growth and high inflation. If we revisit the wonder years of 1970s, when the economy was over regulated, oil shocks had the ability to paralyze the nation and the central bankers still thought there was a trade off between growth and inflation. In 1960s economists Milton and Edmund Phelps challenged the idea of permanent trade off between unemployment and inflation, the experience of the 1970s would seem to bear them out as the inflation had reach double digits and the unemployment had reached 9%. The world economy has had several good years, global growth has been strong, and the divided between the developing countries and developed world has narrowed, with India and China leading the way, even Africa has been doing well, with growth in excess of 5% in 2007. But the good times are ending. There have been worries for years about the global imbalance; Americas ill- conceived war in Iraq helped fuel to quadrupling of oil price

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since 2003. in the 1970s, oil shocks lead to inflation in some countries and to recession elsewhere, as governments raised interest rates to combat rising prices and some economies faced the worst of both worlds; stagflation. The administration now is hoping, somehow, to forestall a wave foreclosure- thereby passing the economys problems on to the next president, just as it is doing with Iraq quagmire. Their chances of succeeding are slim. For America today, the real question is only whether there will by be short, sharp down turn, or a more prolonged, but shallower, slowdown. Moreover, America has been exporting its problems abroad, through the everweaking dollar, for instance Europe; for instance, will find it increasingly difficult to export and in the world economy that had rested on the foundations of a strong dollar the consequent financial market instability will be costly for all. At the time, there has been a massive global redistribution of income from oil importers to oil exporters- a disproportionate number of which are undemocratic states and form workers everywhere to the very rich. It is not clear whether workers everywhere will continue to accept decline in their living standards in the name of an unbalanced globalization whose promises seem ever more elusive. Indeed, the flip side of a world awash with liquidity is a world facing depressed aggregate demand. There is one positive note in this dismal picture; the sources of global growth today are more diverse than they were a decade ago. The real engines of global growth in recent years have been developing countries. Nevertheless, slower growth or possibly a recession in the worlds largest economy inevitably has global consequences. There will be a global slowdown. If monetary authorities respond appropriately to growing inflationary pressure recognizing that much of it is imported, and not a result of excess domestic demand we may be able to manage our way through it. But if they raise interest rates relentlessly to meet inflation targets, we should prepare for the worst: another episode of stagflation. If the central banks go down this path, they will no doubt eventually succeed in wringing inflation out of the system.

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