Stagflation

We've learned that a moderate level of inflation is normally associated with a good economy. But what we saw-- in particular, we saw in the early '70s, in 1973, when the oil embargo hit-- is that we started to experience something called stagflation, or something that was labeled stagflation. It's this weird, bizarre circumstance where you have inflation at the same time as the stagnation in the economy. So that's where they get this kind of combination of words, of stagflation. Let's think about how that would happen. In particular, let's think about how that would happen due to a supply shock. There's other ways that you could get stagflation if you have strange regulations, over-regulation, if the government does weird things. But the classic example is a supply shock. When we say supply shock, it's something like an oil embargo, where all of a sudden the supply of oil, the supply of something, just goes down dramatically. And it could be because of some type of emergency, or it could be literally because of an embargo. And just think about how that would affect the rest of this chain. So if the supply of something dramatically goes down-- We know that supply has an inverse relationship with price. So if supply goes down, then, bam, right there, you see price would immediately go up. And when we think about something like oil, you might say, hey, oil is only the part of my pocketbook where I drive around. But it's not, because even when you buy a fruit, you're really paying for the transportation cost. So the price of oil affects fruit, affects food, affects any good in services. It's one of these things that's pervasive through the economy. So the prices of a bunch of things could generally go up. Well, if the price of a bunch of things generally go up, what's going to happen to demand? Once again, inverse relationship right over here. Demand is going to plummet. If demand plummets, utilization plummets, investment plummets, and profit is going to plummet. And profit's going to plummet now because, one, utilization is going down, and price has gone up. But it's not the price that they can sell things at. Now price is fundamentally a big cost for-- especially if you think of it from a US-centric point of view, if oil is an import, as in the case of the early '70s, then price going up is going to have, I guess they have an inverse relationship. So the price goes up. It's really going to be on the cost side. So once again, hitting profits hard. And if all of these things go down, that's just going to kill employment, kill wages, and then further make demand even worse. So stagflation is that situation where you have some type of shock to the system, where in the classic scenario it hits supply so hard it causes a massive inflation in one part of the economy, and as is the case of oil, a part that affects other parts of the economy. And then all of that kind of throws a monkey wrench in everything else.