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.