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Introduction
In a market economy, competitive mechanisms play an important role. However, the monopoly of producers, not always competent state intervention, the demands of trade unions contribute to its weakening. In the context of a decline in production, monopolists raise prices to ensure stable profit-taking; the state raises taxes and reduces state support for the population and production; trade unions demand higher wages without a corresponding increase in labor productivity. As a result, costs rise, and declining production is accompanied by rising prices; inflation occurs, caused by rising production costs. This state of the economy is defined as stagflation, that is, there is a decline in production amid rising prices for products.
Government Policy Correcting the Output Lost and The Inflation
Macroeconomic equilibrium in the goods market is defined as the equality of aggregate demand and aggregate supply at each of the possible price levels. On the graph (Fig. below), the equilibrium output volume and the equilibrium price level are determined by the intersection of the curves AD and AS.
If the economy already appeared in a state of stagflation at the intersection of AD and AS2, the goal of the policy is to shift the aggregate supply curve to the right to AS. In other words, in terms of the Phillips curve (in any form ‑ an oblique curve or a vertical straight line), the goal of politics is to shift the curve to the left in order to provide an inverse ratio of inflation rates and unemployment rate, more favorable for society.
Stagflation and the ratchet effect are also evident in the decline in production under inflation: production is declining, and the aggregate supply curve shifts up to the left in a short period. In such a situation, it is necessary to clearly define the main danger to the economy: a decline in production or inflation. The stagflation period is characterized by a situation where the combination of inflation and unemployment occurs against the background of economic growth rates that do not allow reaching the pre-crisis level of GDP production and are called “non-investment development.” The dominant importance of reproductive factors in exacerbation of stagflation should also be noted.
It is impossible to fight stagflation with the monetary methods of the Central Bank (changing interest rates, ‘printing money,’ etc.). To ensure that the economy overcomes the crisis, all efforts should be directed towards eliminating the causes of stagflation. Moreover, the measures taken should be of comprehensive nature. The most important of them include disaggregation of monopolies, nationalization of industries that restrain economic development, attracting foreign direct investment; support for consumer demand, state assistance to the socially vulnerable part of the population, small business support.
It is important to highlight the policy of stimulating aggregate demand. The desire of the government to ‘buy’ a lower unemployment rate at the price of inflation is successful only when the so-called false expectations are created by the business agents. Thus, employees, observing the growth of nominal wage rates, increase labor supply. Then, as expected in the concept of the Phillips curve, rising inflation (and the associated increase in nominal wages) can reduce unemployment. However, over time, the population begins to recognize the true price of the attractiveness of high monetary (nominal) wage rates. Indeed, in conditions of inflation, the growth of real wages is not necessarily the same as the growth of its nominal level. If people find that with received money they can buy less goods and services, illusions come to an end and no one intends to increase their labor supply in response to rising cash wages.
As measures to combat stagflation, employment and training policies, a policy of linking wages to prices (incomes), and a policy based on supply theory are used. Employment and professional training programs are designed to address imbalances in the labor market. These include not only the training programs themselves, but also the dissemination of information about jobs and anti-discrimination measures.
The income policy takes two forms ‑ setting benchmarks for wages and prices, as well as controlling them. At the same time, there is a debate among economists about the appropriateness of pursuing such a policy, as it is assessed for its effectiveness and impact on the distribution of resources. Proponents of the supply economy see the origins of stagflation in the growth of the public sector, especially in the negative impact of the tax-transfer system on economic incentives. Other causes of stagflation are the increasing tax wedge between production costs and commodity prices and excessive government regulation of the business. Relying on the Laffer curve, proponents of the supply theory see the primary means of combating stagflation as a significant tax cut, similar to what the Reagan administration did.
A large number of functionalities offers to stimulate demand. However, systemic proposals based on an economic methodology are few and do not fully take into account the current situation ‑ for example, when, in spite of calls to stimulate demand, a serious slowdown in economic growth should be expected. In this situation, one of the possible measures is reduction of the tax burden on small and medium-sized businesses.
Another method of combating stagflation is based on the premise that monopoly market power and imbalances in the labor market are inalienable and inevitable facts of economic life. Proponents of this approach are trying to change the behavior of monopolists in labor and commodity markets in such a way that their decisions on wage rates and price levels better meet the goals of full employment and price stability. Recognizing the difference between wage-pricing policies and wage and price controls, the degree of rigidity of the relevant policy measures has importance. Both the binding policy and the control policy establish certain non-inflationary standards for raising wages and prices. However, if the binding policy relies on their voluntary compliance by workers and entrepreneurs, the control policy gives the established standards the force of law, and, therefore, the government has the right and ability to force unions and company management to obey it.
Conclusion
Nevertheless, complex problems remain in the implementation of these measures and public agreement with them, especially if control over wages and prices is complete and fairly long-term. In such circumstances, the so-called black market is spreading everywhere ‑ the ‘underworld’ market, where prices significantly exceed the statutory upper limit. Moreover, firms manage to circumvent price controls by reducing quality or the size of each unit of output. Thus, it is obvious that the successful solution of problems of overcoming a crisis situation helps to coup with the sources of stagflation in a specific space and time. Therefore, the developed economic policy should be based on real objective facts regarding the macroeconomic situation and be flexible so that the economy can adapt to the current situation.
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