The Real Cause of Stagflation

With another hot PPI report in the news and a shaky AI trade on Wall Street, the potential for a recession and continued inflation calls to mind the stagflation of the 1970s. As Milton Friedman demonstrated, this dreaded combination is the result of central bankers attempting to pull the wool over Americans’ eyes.

The following article was originally published by the Mises Institute. The opinions expressed do not necessarily reflect those of Peter Schiff or SchiffGold.

In the late 1960’s Edmund Phelps and Milton Friedman challenged the popular view that there can be a sustainable trade-off between inflation and unemployment. In fact, over time, according to Friedman, expansionary central bank policies set the platform for lower economic growth and a higher rate of inflation (i.e., stagflation). A famous case of stagflation occurred during the 1974-75 period. In March 1975, industrial production fell by nearly 13 percent year-on-year while the yearly growth rate of the consumer price index (CPI) jumped to around 12 percent.

Starting from a situation of equality between the current and the expected rate of inflation, the central bank decides to attempt to increase the economic growth rate by increasing the growth rate of money supply. As a result, a greater supply of money enters the economy and each individual now has more money at his disposal. According to Friedman, because of this increase, every individual is of the view that he has become wealthier. This raises the demand for goods and services, which, in turn, sets in motion an increase in the production of goods and services.