What Causes Stagflation?

by Frank Shostak

In the late 1960s Edmund Phelps and Milton Friedman challenged the popular view that there can be a sustainable trade-off between inflation and unemployment. In fact, over time, according to PF, loose central bank policies set the platform for lower economic growth and a higher rate of inflation, or stagflation.

PF’s Explanation of Stagflation

Starting from a situation of equality between the current and the expected rate of inflation, the central bank decides to boost the rate of economic growth by raising the growth rate of money supply. As a result, a greater supply of money enters the economy and each individual now has more money at his disposal.

Because of this increase, every individual believes he has become wealthier. This raises the demand for goods and services, which in turn sets in motion an increase in the production of goods and services.

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