CDS (I) 2021 General Knowledge · Question 3 of 120

Correct — C, Stagflation. The word is a portmanteau of stagnation and inflation, and it names precisely the pairing in the stem — output crawling while prices race. It matters because the pairing was long thought impossible. The orthodox reading of the Phillips curve held that inflation and unemployment traded off against each other, so slack growth was supposed to come with easing prices. The rich economies of the 1970s got both at once after the oil shocks, and the word entered the textbooks to describe it. The mechanism usually invoked is a supply shock: when the cost of an input that everything depends on jumps, firms produce less and charge more at the same time, so the price level and the output level move in opposite directions rather than together. That is also why stagflation is hard to treat — tightening money to bring prices down deepens the slowdown, and loosening it to support growth feeds the inflation.

• (a)Stagnation — Only half of the description. Stagnation is prolonged slow or flat growth on its own; it says nothing about the price level, and it is exactly the half that has to be joined to inflation before the compound word applies.
• (b)Deflation — The opposite of the price half. Deflation is a persistent fall in the general price level of goods and services, not a rapid rise, and it should not be confused with disinflation, which is inflation slowing while still positive.
• (d)Recession — Describes falling output — a gradual decline in income, output and employment with business activity in a low gear — and in the standard account it is usually accompanied by weakening rather than rapid inflation. The stem specifies growth that is slow but present, plus fast-rising prices, which is the tighter case.

Demand-pull inflation and output tend to move together, which is why growth is normally coupled with some inflation. Stagflation breaks that pattern by hitting the supply side: a shock to the cost of an essential input, or a lasting fall in productivity, raises prices and cuts output at once. The policy problem is that the two arms of macroeconomic policy pull in opposite directions, so a central bank has to choose which half of the problem to attack first.

This is a vocabulary item, and the reliable method is to split the stem into its two claims — slow growth, rapid inflation — and to ask which option covers both. Stagnation and recession cover the output half; deflation contradicts the price half; only stagflation covers both. The classic episode is the 1970s in the industrial economies after the oil price shocks. Anchoring to the 2021 exam, this was a live question in India: the pandemic year had cut output sharply while retail inflation stayed high, and the term reappeared in commentary again in 2022 when the war in Ukraine pushed energy and food prices up worldwide. The Reserve Bank has generally rejected the label for India, arguing that growth rebounded too quickly for it to apply.

• Stagflation is slow growth or stagnation occurring together with high inflation.
• It is usually traced to an adverse supply shock, which raises costs and cuts output at the same time.
• Its appearance in the 1970s undercut the simple Phillips-curve trade-off between inflation and unemployment.
• Deflation is a persistent fall in the general price level; disinflation is a slowing of inflation that is still positive.
• Recession is a decline in output, income and employment; stagnation is prolonged sluggishness without a price claim.

• Picking stagnation or recession, both of which describe only the output half of the stem.
• Confusing deflation with disinflation.
• Assuming slow growth must always mean falling prices — that assumption is exactly what stagflation refutes.

As a define-the-term item in either direction, or as a statements question on what a supply shock does to output and prices.

• practice — not a real PYQ

  A sharp and sustained rise in crude oil prices in an oil-importing economy is most likely to produce

  • (a)deflation with rapid growth
  • (b)higher output together with lower prices
  • (c)lower output together with higher prices
  • (d)no change in either output or prices

  Answer(c) lower output together with higher prices — an adverse supply shock raises costs, so firms produce less and charge more, which is the stagflationary combination.

• practice — not a real PYQ

  A persistent fall in the general price level of goods and services in an economy is called

  • (a)disinflation
  • (b)deflation
  • (c)devaluation
  • (d)depreciation

  Answer(b) deflation — disinflation is inflation that is slowing but still positive, while devaluation and depreciation refer to the external value of the currency.