Answer to Question #93707 in Macroeconomics for Debby

Question

what are the possible explanation for the recent failure of fiscal and monetary policy to solve the stagflation problem?

Answer 1

In the short term, there is an inverse relationship between the inflation rate and the unemployment rate: an increase in employment leads to inflation, since when there is a shortage of resources, they are "poached" by raising wage rates and prices for investment goods. The economic downturn causes a reduction in employment and aggregate demand, which leads to disinflation or even deflation.

Stagflation is closely linked to inflation of supply and demand. And the reasons are the structural imperfection of the market and the lack of competition, as monopolies have no incentive to reduce costs.

An expansionary monetary policy that lowers interest rates increases the deficit of payments in the United States. This is due to the fact that enterprises (foreign or domestic) borrow dollars here and send them abroad to build factories or cause a series of official and actual devaluations of the dollar. This leads to inflation, because now cheaper American products in global markets will be in high demand.

That is, the stabilizing internal monetary (but also fiscal) policy is limited by its effect on the balance of payments.

I am of the opinion that stagflation is caused by monopolies and their power over the market. After all, the demand curve of the monopolist firm coincides with the demand curve for the product, therefore, the quantity of products that can be sold increases as the price decreases, and it is often more profitable for the monopolist to produce less and sell more expensive.