Which of the following will cause stagflation?
a. an increase in the money supply
b. an increase in oil prices
c. a decrease in the money supply
d. technical progress
The correct answer and explanation is :
The correct answer is b. an increase in oil prices.
Explanation:
Stagflation refers to a situation where an economy experiences stagnant economic growth, high unemployment, and high inflation simultaneously. This is a challenging economic scenario because inflation and unemployment usually have an inverse relationship, meaning that policies that reduce inflation typically increase unemployment, and vice versa.
Let’s break down the options and understand why an increase in oil prices (option b) can lead to stagflation:
- An increase in the money supply (option a):
- When the central bank increases the money supply, it can lead to inflation, but typically this would not cause stagnation or high unemployment in the short term. In fact, an increase in the money supply often stimulates economic activity. It would lead to demand-pull inflation rather than the combination of high inflation and high unemployment seen in stagflation.
- An increase in oil prices (option b):
- A sharp increase in oil prices can lead to cost-push inflation, where the cost of production rises because oil is an essential input for many industries (such as transportation and manufacturing). Higher oil prices raise costs for businesses, which then pass these higher costs onto consumers in the form of higher prices (inflation). At the same time, the higher costs can lead to reduced economic output because businesses may scale back production or even lay off workers due to increased operating costs, leading to higher unemployment. Thus, an increase in oil prices can cause stagflation, as both inflation and unemployment rise simultaneously.
- A decrease in the money supply (option c):
- A decrease in the money supply usually leads to disinflation (a decrease in the rate of inflation) and can cause economic contraction. It does not typically cause the simultaneous high inflation and high unemployment associated with stagflation. Instead, it would likely lead to lower inflation and lower demand, but not stagflation.
- Technical progress (option d):
- Technological improvements typically enhance productivity, which can lead to economic growth. This would generally decrease the cost of production and reduce inflationary pressures, not cause stagflation. If anything, technological progress is more likely to help the economy grow, not stagnate.
In conclusion, an increase in oil prices (option b) is the primary factor that can lead to stagflation, as it creates cost-push inflation and can simultaneously reduce economic output, resulting in both higher inflation and unemployment.