The relationship between economic inflation and economic stagnation

 Relationship between economic inflation and economic stagnation

Inflation and economic stagnation are both important aspects of the macroeconomy, which means that they affect the economy as a whole, therefore, understanding these aspects can help in making the right decisions to protect investments and assets.

The relationship between economic inflation and economic stagnation

The main difference between inflation and stagnation is that economic inflation is a term that refers to the general increase in price levels while stagnation is a term that refers to the level of decline in economic activity.

Moreover, stagflation is a term that economists use to define an economy with inflation, a slow or stagnation rate of economic growth, and a relatively high unemployment rate, as economic policymakers around the world try to avoid stagflation at all costs.

Especially with stagflation, citizens of a country with high rates of inflation and unemployment are affected, and at the same time, high unemployment rates contribute to a slowdown in the economy of any country, causing the rate of economic growth to fluctuate by no more than one percentage point above or below zero.

Concept of economic inflation

Economic inflation is the emergence of relative changes in price levels for the year by relying on the use of the consumer price index; Because it shows the quantity of supply of goods and services, whether they are produced locally or imported.

It also defines economic inflation as a continuous increase in the prices of products and services, and government agencies are unable to control it.

Among other definitions, economic inflation is the emergence of a gradual rise in prices as a result of an expansion in demand or supply or an increase in costs.

Reasons for the emergence of economic inflation

Economic inflation is one of the economic phenomena caused by a number of reasons, the most important of which are:

  • High costs of production.
It is the emergence of an increase in the prices of products and services as a result of an increase in production costs, which means that the prices of services related to production factors rise at a rate that exceeds their marginal production. This increase in the stability of production leads to an increase in the cost of production and thus an increase in the selling price in order to avoid a decrease in profits.

  • An increase in aggregate demand.
Any emergence of excessive demand for products and services, which means an increase in demand oversupply, and consequently a rise in the prices of these products.

  • Decreased overall width.
This defect is caused by several factors, the most important of which are:

  1. Lack of production elements such as staff and raw materials.
  2. Inadequate production, due to the use of old production methods that do not meet the modern requirements of the market, or the lack of technical factors for production.
  3. full use of the factors of production; Which leads to the inability of the production apparatus to provide all the needs of high demand.
  • The effect of bank interest.

Where banks keep a small percentage of the value of deposits and not the entire value, which leads to the issuance of large times of money for deposits, which results in a rise in the money supply, which contributes to the emergence of monetary inflation, and reliance on loans as a means to reduce the gap between demand and supply.

  • Natural disasters and wars.

Both lead to a decline in production and a decrease in the proportion of supply, and consequently the emergence of weakness in the local currency and a budget deficit.

  • Reliance on imported goods and services.
This appears in small economic sectors that meet their needs by importing products from other economic sectors, which affects their selling prices, which rise in local markets.

What are the effects of inflation

Among the most prominent negative effects resulting from economic inflation are the following:

  • The effect of inflation on the purchasing power of money.
The continuous rise in the prices of services and goods leads to a loss of part of the purchasing power of the currency, and this is reflected in the weakening of people's confidence in the national currency and the purchase of durable goods, hard currencies and real estate. Fearing that their prices will rise in the future, which impairs the saving process and the currency loses its function as a store of value.

  • Inflation and production structure.
Economic inflation directs capital to economic activities that do not benefit the economic renaissance in its early stages, due to the high prices and profits of the productive sectors devoted to the production of consumer goods. And this is at the expense of investment and production activities, which are the basis for achieving economic growth.

  • Effects of Inflation on Savings.
If companies and governments are not balanced in spending on consumption, their ability to invest and save in the future will decrease.

  • Effects of Inflation on Wealth Distribution.
Central banks resort to raising the interest rate to reduce demand levels, thus employees and workers are harmed due to the decrease in the real value of their salaries.

  • Effects of inflation on the balance of payments.
The rise in domestic prices leads to a decrease in the competitiveness of a country's exports compared to the prices of its competing countries' commodities. This leads to a decrease in the exports of that country, which results in a deficit in the balance of payments.

In spite of this, countries experiencing economic stagnation have inflation as a target, as is the case when economic growth declines significantly, or when countries register deflation, which causes competent governments to take measures that help raise the level of demand for services and goods.

Therefore, the presence of an acceptable amount of economic inflation will encourage producers to continue production in order to obtain profits, but in return, the large rise in inflation rates leads to negative economic effects as we explained previously.

Definition of economic recession

An economic recession is a decline in economic activities that leads to a decline or negative growth in a country's GDP, for a period of 6 months or more.

This results from the imbalance between production and consumption. Most of the recessions in the world were short-lived, and long-term economic stagnation is called economic depression, and if it is serious, it is described as economic collapse.

There are those who oppose the definition of economic stagnation among the economists for two reasons:

  • It does not take into account changes in indicators, and among these changes are the unemployment rate and consumer confidence.
  • Determining the quarterly period makes it difficult to determine when an economic recession begins and ends, i.e. a recession that lasts for ten months cannot be monitored.

Another interpretation of the definition of an economic recession is that it occurs after economic activity including industrial production, retail sales and employment reaches its peak and then begins to decline, and the recession continues until economic activity recovers and begins to rise.

Reasons for an economic recession

The reasons that lead to economic stagnation vary, and the most important of them are the following:

  1. Inflation is the most important contributor to economic stagnation.
  2. Natural disasters and wars: The resources of the economy are wasted, and GDP can be severely affected.
  3. Unemployment: Due to the increased cost of production and high inflation, companies have to lay off a number of workers, which in turn reduces the number of goods produced.
  4. Government policy: the government implements several measures such as price and wage control, and these measures are considered unfavorable by companies and investors. So economic activity will suffer.

Effects of the economic recession

The most important effects of the economic recession are as follows:

  • Decreased level of aggregate demand due to declining consumption and investment.
  • Decreased tax revenue due to declining profits for individuals and companies.
  • Expansion of bankrupt companies due to reduced demand for their products.
  • Unemployment rates are high.
  • The decline in the value of assets such as stocks and real estate as a result of the decline in speculative activity.

An example of stagflation

When the government prints currency (the money supply increases which leads to inflation), while it raises taxes (which slows economic growth) it leads to stagflation.

Treating stagflation

There is no definitive cure for stagflation. The consensus among economists is that productivity should be increased to the extent that it leads to higher growth without additional inflation. This would then allow monetary policy tightening to rein in the inflationary component of stagflation.

(And that's easier said than done, so the key to preventing stagflation is to be very proactive in avoiding it.)

History of stagflation

It has long been thought that stagflation is "impossible" because the economic theories that have dominated academia and politics have excluded it from their models by constructing in particular the economic theory of the Phillips curve that developed in the context of Keynesian economics portrayed macroeconomic policy as a trade-off between unemployment and inflation.

As a result of the Great Depression and the rise of Keynesian economics in the twentieth century, economists became preoccupied with the risks of deflation, arguing that most policies designed to reduce inflation tended to make it more stringent for the unemployed, and policies designed to reduce unemployment (raise inflation).

Stagflation across the developed world in the mid-20th century demonstrated that this was not the case, and as a result, stagflation is a great example of how realistic economic data can sometimes defeat widely accepted economic theories and policy prescriptions.

Since that time, as a rule, inflation has persisted as a general condition even during periods of slow or negative economic growth. In the past fifty years, every declared recession in the United States has seen a continuous year-on-year rise in the level of consumer prices.

The only and partial exception to this is the lowest point of the 2008 financial crisis – and even then the price decline was confined to energy prices while overall consumer prices other than energy continued to rise.

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