Depression, Recession, and Stagnation

The Special Case of Stagflation

Growth has usually been associated with inflation and more or less full employment, whereas recession and depression are characterized by deflation and unemployment. Economists did not conceive of a state of affairs where inflation could coexist with unemployment and stagnation. However, the new phenomenon of stagflation upset previous economic theories. The word stagflation was first used by the British politician Iain Macleod in a speech in Parliament in 1965 in which he pointed out that the country was now threatened by both inflation and stagnation. The threat became more menacing in subsequent years when the oil price shock led to a general increase in prices. Workers then asked for higher wages, initiating a vicious circle of wage hikes and price increases as well as an increase in unemployment. Stagnation in this new form has rivaled recession and depression as a major impediment to economic growth.

Analyses and Theories

The experience of recurrent recessions and depressions has given rise to many attempts at analyzing the causes and effects of these phenomena. The dynamics of recovery from recessions were outlined in three curves, a V-shaped curve of sharp decline and rapid recovery, a U-shaped curve of prolonged depression, and an L-shaped curve of more or less steep decline with no recovery but [Page 392]a transition to stagnation. The U.S. recession of the mid-1950s serves as a demonstration of the V-curve. A peak at the end of 1952 was followed by a trough at the end of 1954. The U.S. economy then quickly climbed to a new peak in early 1955. The U-shaped curve corresponds to the experience of the Great Depression of the 1930s, and the L-shaped curve mirrors the fate of Japan, where an asset bubble burst in the late 1980s. The economy then declined steeply into a trough in the early 1990s; there was no recovery at that time but a transition to a long period of stagnation that was called Japan's “lost decade.”

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