Revision - Stagflation

Stagflation refers to a combination of stagnant economic growth and high and rising inflation. Some economists also add in rising unemployment into the dangerous stagflation mix! In this situation it becomes difficult to manage the economy because, on the one hand, companies and employees are suffering from slow-growing or falling production (which can lead to weaker profits and job losses), whilst prices are rising more quickly which threatens our real standard of living.

Stagflation was widely scene in the mid 1970s and also in the late 1980s. But for most of the last fifteen to twenty years the UK economy, along with many other countries, has enjoyed a period of remarkable macroeconomic stability. However in 2007-08 we saw the re-emergence of this idea due to a combination of economic events from home and overseas.

The credit crunch, a slump in property prices and the effects of soaring commodity prices caused a fall in consumer confidence and hit people’s real disposable incomes. Inflation was stoked up by big increases in the prices of petrol, diesel, electricity, gas, basic foods and other products that use oil and foodstuffs as essential inputs. A depreciation in the value of the sterling exchange rate against the US dollar and the Euro also served to increase inflationary pressures in the UK because it increased the costs of importing goods and services. CPI inflation in the UK peaked at just over 5% in the autumn of 2008 – more than twice the official inflation target – before falling back.

When stagflation starts to appear, this makes life difficult for the Monetary Policy Committee of the Bank of England. They are pulled between the need to keep inflation within target range and avoid an economic slump – both of which can cause huge short term and longer term damage.

Have stagflation fears now eased for the UK and international economy. Our top chart shows that international commodity prices have dropped a long way from their recent peaks – and this has certainly helped to keep stagflation at bay.

But the recession is a very deep one and inflation risks have not gone away. A rebound in the world economy could easily drive oil, gas, metals and food prices higher once more.