How does stagflation differ from the traditional business cycle?
Stagflation differs from the traditional business cycle in that it consists of inflation coupled with high rates of unemployment and lower growth in real Gross Domestic Product (GDP).
In the traditional business cycle, inflation and unemployment are supposed to be symptoms of different problems in the economy. Inflation occurs as the business cycle heats up. Aggregate demand rises, GDP rises, and the economy starts to “overheat.” When this happens, average prices rise, which is the definition of inflation. Conversely, unemployment occurs as the business cycle cools down. Aggregate demand drops. GDP drops. The economy loses steam. There is less demand so there are fewer jobs and people become unemployed. Because people are unemployed, there is little upward pressure on wages and prices.
What this means is that unemployment is not supposed to happen at the same time as inflation. This makes stagflation different because stagflation consists of both of these problems happening at the same time.