stagflation

Normally an economy gives you one problem at a time: in a boom, prices rise but jobs are plentiful; in a slump, jobs vanish but prices ease. Stagflation is the cruel exception where you get the worst of both at once — prices climbing and the economy stalling, with unemployment high and growth flat. It is like a fever and chills together, and it leaves policymakers in a genuine bind, because the usual cures for one ailment make the other worse.

Stagflation is the combination of stagnation (low or negative growth and high unemployment) with high inflation. The word fuses "stagnation" and "inflation." It shocked economists when it appeared in the 1970s, because the prevailing belief held that inflation and unemployment moved in opposite directions, so you could not have both badly at once. Its classic cause is a large adverse supply shock — such as the 1970s oil price spikes — which simultaneously raises costs (driving inflation) and chokes off production (driving unemployment).

Stagflation is so feared because it puts policy in a trap. To fight inflation, a central bank raises interest rates, which slows the economy further and worsens unemployment. To fight unemployment, it cuts rates or boosts spending, which fuels even more inflation. There is no easy lever that helps both, so the response is usually slow and painful. Stagflation is the textbook reason economists distinguish cost-push (supply-side) from demand-pull inflation: only a supply shock can push prices up and output down at the same time.