Stagflation

Stagflation

Inflationary gap occurs when aggregate demands exceed the available supply and deflationary gap occurs when aggregate demand is less than the available supply. These are two opposite situations. However, we may show how deflationary forces follow inflation, which has not been controlled. For instance, when inflation goes unchecked for sometimes and priCes reach very high levels, aggregate demand contracts and slumps follows. Consumption demand (C) declines because of high price levels. The middle and lower-income groups have to curtail th<f” consumption of many of the goods. Increase in private investment (I) does not take place because investors are afraid of future and there is decline in consumer demand at the height of inflation. In fact, the decline in consumer demand and private investment will reinforce each other and create a deflationary situation. Further, un excessive rise in the price ‘level will affect exports adversely and thus create a slump in the export industries as well. It is, thus, possible to visualise a situation in which inflationary and deflationary pressures are present simultaneously. The existence of an economic recession at the height of inflation has been called as stagflation (stagnation + inflation).