The situation in an economy when inflation and unemployment both are at higher levels is known as __________.
- A.stagflation
- B.inflation premium
- C.inflationary gap
- D.reflation
Show answer
Correct answer: A. stagflation
Explanation
The correct answer is A, stagflation. Stagflation is a blend of the words stagnation and inflation: output stops growing, unemployment rises, and yet prices keep climbing. Normally inflation and unemployment move in opposite directions, as the Phillips curve shows, so stagflation is a puzzle for policy makers, because raising interest rates to cool prices worsens unemployment while spending to create jobs pushes prices higher. The classic example is the 1970s, when the oil price shocks of 1973 and 1979 hit western economies with slow growth and double-digit inflation at the same time. B is wrong because an inflation premium is the extra return lenders demand to make up for expected inflation. C is wrong because an inflationary gap is the amount by which total demand exceeds full-employment output, a situation of too much demand, not of high unemployment. D is wrong because reflation is a deliberate policy of boosting demand to lift an economy out of a slump. Exam tip: stagflation equals high inflation plus high unemployment plus stagnant growth, remembered by the 1970s oil crisis.