Stagflation, Philips Curve and more

What is Stagflation?
Stagflation is special form of Inflation when two worse things happen simultaneously:-

• High rate of inflation
• High rates of Unemployment (Slow Economic Growth)

Why Stagflation Occurs?

It generally happens due to sudden shocks, for example if the price of oil increases then an oil importing company will face high rates of inflation suddenly as the production and transportation costs increase, while the unemployment increases in such situations. It can also happen due to inappropriate Monetory policies, which try to reduce the unemployment rates in the short run but ultimately end up in increasing the inflation rates without the reduction in the unemployment rate. For a clear picture of causes refer here. 

Philips Curve

In early times it was considered that the inflation and unemployment were inversely related. According to this curve, the lower rates of unemployment is achieved at the cost of high rates of inflation, simply put inflation rates are high when unemployment rates are low and vice versa.

This model came under attack when situations arrived (in USA in particular), when both the rates were high, ie Stagflation occurred.  As such it was argued that the Phillips curve was only valid in the short run and in the long run unemployment and wage rates took into consideration the expected levels of inflation.