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Economics

Stagflation: a Historical Review

Stagflation: a Historical Review
DAWN ebr 10/3/2014

Stagflation refers to a combination of two major undesirable economic conditions: the economy slowing down (stagnation), coupled with prices climbing up sharply (inflation).

According to the chart, FY1981 to FY1988 witnessed high economic growth with low inflation. Between FY1989 to FY2000, there was moderate growth with high-to-moderate inflation. And during FY2005 to FY2012, the gap between economic growth and inflation rose dramatically, leading the economy into the dangerous abyss of ‘stagflation’.

There are three over-simplified root causes of stagflation. First is the increase in oil prices. Oil is an input for generating economic activity, including electricity production (thermal power generation), running factories, and transportation.

And since Pakistan imports a great deal of oil from abroad, naturally, when international prices of crude oil and petroleum products go up, it automatically results in inflation.

Secondly, when the government prints money, it results in inflation.

And thirdly, when the local currency weakens against the dollar, as it did over the last few years, imported goods become expensive.

In simple words, when the cost of carrying out commercial activity goes up, the economy slows down, as is happening now. And when the government mismanages public finances, it leads to stagflation.

In recent times, the federal government has, on several occasions, heavily borrowed money from the State Bank of Pakistan, and relied on currency printing for deficit financing.

Stagflation is a double-edged sword for the poor (have-nots), as earning opportunities vanish while prices of basic commodities go up. The gap between the country’s ‘haves’ and the ‘have-nots’ has recently increased to an alarming level. Pakistan’s middle class, which is considered the backbone of any economy, has been adversely hit by the ongoing stagflation.

It is difficult to deal with stagflation when it occurs. However, if the government is sincere, it should right-size its sprawling administrative structure and widen the tax net in order to decrease its reliance on borrowing or currency printing — deficit financing. It should minimise the fiscal imbalances.

Generally, we tend to underestimate the resilience and dynamics of the national economy. Pakistan conducted nuclear tests amidst fears of economic collapse. However, the invisible power of the economy and cooperation of some friends made it possible for the country to survive the shock. This shows that our economy has evolved into a force which can survive even deeper turmoil.

But the disturbing fact is that the ruling elite seems to believe that they can skim the common citizen with any restraints, and it has shown no interest in evolving a strategy for people-centred development.

Perhaps, this can only be realised by an active citizenry, which is able to get electoral mandate implemented by the representatives. As the Economist London puts it, ‘there is far more to democracy than holding elections’.

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