Causes of Stagflation in a Market Economy

The stagflation means in a market economy the economy experience high rates inflation at low levels of employment or higher levels of unemployment. This has occurred in many market economies in the 1970’s and 1980’s. However, there is no consensus between economists regarding the causes of stagflation. As well, in different countries the rates of inflation and unemployment levels or the levels of stagflation vary to some extent. In addition, different polices to address stagflation had different effectiveness.

In some countries, the problem of stagflation persists even in some of the advanced market economies. In this article I propose to discuss the economic arguments put forward by orthodox economists and in the perspectives of alternative eclectically analyzing the issue of stagflation and the policy implications.

The causes of inflation according to orthodox economic point of view

In the perspective of monetarists the inflation is primarily a monetary phenomenon. That is according the monetarist economists inflation is caused primarily because of money supply as an aggregate in an economy. That is they do not consider other non-monetary factors contributing to the reduction in the purchasing power of money.

However, all economists do not agree that inflation in all times is not due to monetary factors alone. For example some economist point of view cost-push factors can be a major factor contributing at least in some economies other than money supply issues. That is, the labor market conditions and trade union activity can contribute to inflation if trade unions play an important role in the labor market. As well, some sociological factors can be a major factor in cost-push inflation. For example in UK and in some other advanced market economies the trade union militancy and excessive wage bargaining power has been very high and they have higher rates of inflation than other countries which have lesser trade union power in the labor market. That is, inflation factors can be other than monetary factors or money supply factors in an economy. In addition, monetary policy to reduce inflation if inflation is caused primarily by cost-push factors it was found that to control inflation by monetary policy alone was ineffective. In effect, cost push factors can be an important inflationary cause in many countries and there may be a combination of causes of inflation in varying degrees from one country to the next.

In addition, to the above some economist point of view supply side factors can be a cause of inflation. That is, oil price increases and the imperfection in the goods market, competition and other monetary mismanagement and fiscal mismanagement can be cause for inflation. That is inappropriate government regulation or deregulation and in appropriate macroeconomic policies can be a cause for inflation. That is, supply side factors and inefficiencies and distortions in market mechanisms may have a major impact on inflationary pressures and can contribute to inflation as well high levels of unemployment.