Stagflation

1970’s- early1980’s

MD Siyam HossainBangladesh Institute of Business & TechnologyNarayangonj,DhakaDhaka,Bangladesh

Introduction Stagflation occurred in the late 1970s-early 1980’s

High inflation + unemployment + recession = Stagflation.

Effective scenario Prices increase for goods and services while people were

unemployed/ loosing jobs. Purchasing power in North America fell as wealth was

transferred from oil consuming countries to oil producing countries.

In 1981 Canadian inflation reached an annual rate of

12.5%.

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Economic Theory Traditional Economic Theory

In the 1960s it was thought that the Phillips curve (Keynesian economics) suggested Stagflation is impossible because high unemployment lowers

demand for goods and services which lowers prices.

1970s and 1980s- actual stagflation occurred The relationship between inflation and employment levels was

not a constant.

Shock Theory Outside forces to an economy or "exogenous" factors. In this

view stagflation is thought to occur when there is an adverse shock (i.e. increase in energy costs- oil prices), in a country's aggregate supply curve.

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Measures Central Banks and Governments affect the economy

through fiscal and monetary policy.

Stagflation creates a policy bind where attempting to correct one problem creates another.

Central Bank (BOC) does not have a effective counter measures (both negatives)-

Hiking interest rates in order to calm inflation slows down an already too-slow economy and may contribute to further unemployment

Lowering interest rates speeds economic growth by increasing the money supply but also accelerates inflation

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Inflation

Demand-Pull Inflation An excess of spending beyond economy’s potential

causes price to increase.

Cost-Push Inflation An increase in nominal wages or input costs reduces

the supply of goods causing prices to increase.

Recession

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The options

Fight Inflation Try to push inflation

downward Recession deepens,

causing a loss of real output and higher unemployment.

Fight recession Try to eliminate the

recessionary gap by pushing towards full employment.

The employment rate goes up, but an inflationary spiral may occur.

Pick the lesser of two evils.

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Bank of Canada’s response

Actions:Actions: Policy induced recession. Gradually reduced the rate of money growth. Resort to crush inflation. BOC targets ‘zero inflation, by 1988. Canada, U.S and Britain raised interest rates to new highs (> 20% in

1980). Acceptance of unemployment rate of 10% and above.

Effects:Effects: Economic turmoil, very high unemployment rates Inflationary expectations reduced and so interest rates slashed. Loss of confidence in government’s ability to manage the economy.

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Bank of Canada’s response

http://www.bcrealtor.com/d_bkcan.htm

http://www11.hrsdc.gc.ca/en/cs/sp/hrsdc/arb/publications/quarterlies/2002-000061/images/graph32.gif

http://www.chass.utoronto.ca/~echist/lec15.htm

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Overlap of Graphs

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Bank of Canada

Body in charge of regulating “credit and currency in the best interest of the nation”

Policy: price stability = high, long-term growth 3 goals in inflation policy:

Creating confidence in money Having a framework Being predictable

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How it works

Chooses target rate 2% midpoint of between 1-3%

Uses CPI as key indicator With more volatile elements excluded

Has a timeframe 18 mo. to 2 years

Symmetry Going below target is also problematic

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Success

Inflation ‘91 was 5% By ‘95 it was 2% Less volatility in business cycle Canada 2nd to adopt inflation targeting after

NZ Now 20 countries do it, including US

Allows Canada to respond to crises

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Future?

Price targeting Lower than 2% inflation

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Target

The Bank of Canada aims to keep inflation at the 2 per cent target, the midpoint of the 1 to 3 per cent inflation-control target range.

Bank uses a measure of core inflation as an operational guide.

Core inflation provides a better measure of the underlying trend of inflation and tends to be a better predictor of future changes in the CPI.

Core inflation - the CPI that excludes the eight most volatile components —which account for 19 per cent of the CPI basket—(fruit, vegetables, gasoline, fuel oil, natural gas, mortgage interest, intercity transportation, and tobacco products) as well as the effect of changes in indirect taxes on the remaining components.

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Current Inflation DataBank of Canada web site

Inflation (year-over-year percentage change)

2004Q3

2004Q4

2005Q1

2005Q2

2005Q3

2005Q4

2006Q1

2006Q2

2006Q3

Latest data

Core inflation 1.6 1.6 1.8 1.6 1.6 1.6 1.7 1.8 2.0Jul

CPI excluding food, energy, and the effect of changes in indirect taxes

1.1 1.1 1.4 1.2 1.4 1.4 1.4 1.6 1.9Jul

CPIW 1.7 1.8 1.7 1.7 1.9 1.8 1.8 1.8 1.5Jul

Updated: 06 September 2006 Next update: 19 October 2006

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Unemployment Bank of Canada web site

Labour market 2004Q3

2004Q4

2005Q1

2005Q2

2005Q3

2005Q4

2006Q1

2006Q2

2006Q3

Latest data

Unemployment rate (%) 7.1 7.1 7.0 6.8 6.8 6.5 6.4 6.2 6.4Jul

Participation rate (%) 67.4

67.5

67.3

67.2

67.1

67.1

67.1

67.2

67.3Jul

Growth in employment (annualized rate, %) 0.6 1.4 0.9 1.7 1.5 2.4 1.6 3.1 -0.0Jul (1)

Skilled labour shortage (% firms) - Manufacturing (Statscan survey) 7.0 7.0 5.0 7.0 8.0 9.0 6.0 8.0 9.0Q3

Labour shortage (% firms) - All sectors (Bank of Canada Regional Office Survey)

44.0 36.0 33.0 36.0 51.0 49.0 44.0 27.0

27.0Q2

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Conclusion

Two choices – fight inflation or fight recession Bank of Canada chose to fight inflation It worked, but slowly. Current policy – 2% inflation (1-3%) Economics is evolving

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References McConnell, Brue, and Barbiero. Macroeconomics, 8th Canadian Ed. 1999, McGraw-

Hill Ryerson. Lovewell. Understanding Economics: A Contemporary Perspective, 3rd Ed.2005,

McGraw-Hill Ryerson. http://www.sfu.ca/~grubel/_private/CSV%20Monetary%20and%20Exchange%20Rate%20Policies.doc http://www.chass.utoronto.ca/~echist/lec15.htm http://www.mapleleafweb.com/features/economy/bank_canada/role.html www.bankofcanada.ca/en/speeches/2005/sp05-18.html

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