August 23, 2022
The term “stagflation” has been surfacing across many media outlets recently. Many economists see similarities between today’s world economy and the stagflationary period of the 1970s, although some agree that the current macroeconomic environment today cannot be compared with what happened during the 1970s.
Saying the word “stagflation” may just be another tactic from the news and media outlets to generate more exciting headlines, however, stagflation is a real term coined by the economist Iain MacLeod in 1965. This term refers to a period of time when the economy is experiencing recession and high inflation simultaneously. So, theoretically, stagflation is worse than inflation. Why exactly is that? In order to answer this, we will look at the definition of inflation and stagflation, and how it can be considered worse than just inflation.
What is inflation?
Inflation is a relatively simple term to understand: it is used to define an overall rise in prices, meaning a decline in purchasing power. Purchasing power is simple: it measures how much goods or services we can obtain based on a certain unit of currency. For example, in the year 1900 you could buy 10 boxes of cereal for only $1! Nowadays, what can a single dollar buy? a can of soda?
Many Western economies like the United States believe that a small amount of inflation is good, as inflation encourages consumer spending and limits the risk of deflation. With a small amount of inflation, people are encouraged to buy now, as the item may become more expensive the longer they wait.
The opposite is true for deflation: as consumers expect prices to drop during a deflationary period, they may hold out on a purchase and wait until the item becomes cheaper before buying. This encourages people to spend less, as they wait for better deals. The United States Federal Reserve believes that a benchmark inflation of 2% per year is considered healthy.