The document discusses stagflation that occurred in the late 1970s to early 1980s. Stagflation is defined as high inflation combined with high unemployment and economic recession. It was caused by external shocks like increased oil prices which raised production costs. Central banks faced a policy dilemma of whether to prioritize fighting inflation or recession. The Bank of Canada chose to target inflation, gradually reducing money supply growth and accepting short-term higher unemployment. This slowed inflation over time, though it caused economic turmoil initially. The Bank of Canada now uses an inflation target of 2% to guide monetary policy decisions.

1. Stagflation
1970’s- early1980’s
MD Siyam Hossain
Bangladesh Institute of Business & Technology
Narayangonj,Dhaka
Dhaka,Bangladesh

2. Introduction
 Stagflation occurred in the late 1970s-early 1980’s
 High inflation + unemployment + recession = Stagflation.
 Effective scenario
 Prices increase for goods and services while people were
unemployed/ loosing jobs.
 Purchasing power in North America fell as wealth was
transferred from oil consuming countries to oil producing
countries.
 In 1981 Canadian inflation reached an annual rate of
12.5%.
MD Siyam Hossain

3. Economic Theory
 Traditional Economic Theory
 In the 1960s it was thought that the Phillips curve (Keynesian
economics) suggested
 Stagflation is impossible because high unemployment lowers
demand for goods and services which lowers prices.
 1970s and 1980s- actual stagflation occurred
 The relationship between inflation and employment levels was
not a constant.
 Shock Theory
 Outside forces to an economy or "exogenous" factors. In this
view stagflation is thought to occur when there is an adverse
shock (i.e. increase in energy costs- oil prices), in a country's
aggregate supply curve.
MD Siyam Hossain

4. Measures
 Central Banks and Governments affect the economy
through fiscal and monetary policy.
 Stagflation creates a policy bind where attempting to
correct one problem creates another.
 Central Bank (BOC) does not have a effective counter
measures (both negatives)-
 Hiking interest rates in order to calm inflation slows
down an already too-slow economy and may contribute
to further unemployment
 Lowering interest rates speeds economic growth by
increasing the money supply but also accelerates
inflation
MD Siyam Hossain

5. Inflation
 Demand-Pull Inflation
 An excess of spending beyond economy’s potential
causes price to increase.
 Cost-Push Inflation
 An increase in nominal wages or input costs reduces
the supply of goods causing prices to increase.
 Recession
MD Siyam Hossain

6. The options
 Fight Inflation
 Try to push inflation
downward
 Recession deepens,
causing a loss of real
output and higher
unemployment.
 Fight recession
 Try to eliminate the
recessionary gap by
pushing towards full
employment.
 The employment rate
goes up, but an
inflationary spiral may
occur.
Pick the lesser of two evils.
MD Siyam Hossain

7. Bank of Canada’s response
 Actions:Actions:
 Policy induced recession.
 Gradually reduced the rate of money growth.
 Resort to crush inflation. BOC targets ‘zero inflation, by 1988.
 Canada, U.S and Britain raised interest rates to new highs (> 20% in
1980).
 Acceptance of unemployment rate of 10% and above.
 Effects:Effects:
 Economic turmoil, very high unemployment rates
 Inflationary expectations reduced and so interest rates slashed.
 Loss of confidence in government’s ability to manage the economy.
MD Siyam Hossain

8. Bank of Canada’s response
http://www.bcrealtor.com/d_bkcan.htm
http://www11.hrsdc.gc.ca/en/cs/sp/hrsdc/arb/publications/quarterlies/2002-
000061/images/graph32.gif
http://www.chass.utoronto.ca/~echist/lec15.htm
MD Siyam Hossain

9. Overlap of Graphs
MD Siyam Hossain

10. Bank of Canada
 Body in charge of regulating “credit and
currency in the best interest of the nation”
 Policy: price stability = high, long-term growth
 3 goals in inflation policy:
 Creating confidence in money
 Having a framework
 Being predictable
MD Siyam Hossain

11. How it works
 Chooses target rate
 2% midpoint of between 1-3%
 Uses CPI as key indicator
 With more volatile elements excluded
 Has a timeframe
 18 mo. to 2 years
 Symmetry
 Going below target is also problematic
MD Siyam Hossain

12. Success
 Inflation ‘91 was 5%
 By ‘95 it was 2%
 Less volatility in business cycle
 Canada 2nd
to adopt inflation targeting after
NZ
 Now 20 countries do it, including US
 Allows Canada to respond to crises
MD Siyam Hossain

13. Future?
 Price targeting
 Lower than 2% inflation
MD Siyam Hossain

14. Target
 The Bank of Canada aims to keep inflation at the 2 per
cent target, the midpoint of the 1 to 3 per cent inflation-
control target range.
 Bank uses a measure of core inflation as an operational
guide.
 Core inflation provides a better measure of the
underlying trend of inflation and tends to be a better
predictor of future changes in the CPI.
Core inflation - the CPI that excludes the eight most volatile components —which account
for 19 per cent of the CPI basket—(fruit, vegetables, gasoline, fuel oil, natural gas,
mortgage interest, intercity transportation, and tobacco products) as well as the effect
of changes in indirect taxes on the remaining components.
MD Siyam Hossain

15. Current Inflation Data
Bank of Canada web site
Inflation (year-over-year percentage
change)
2004
Q3
2004
Q4
2005
Q1
2005
Q2
2005
Q3
2005
Q4
2006
Q1
2006
Q2
2006
Q3
Latest
data
Core inflation 1.6 1.6 1.8 1.6 1.6 1.6 1.7 1.8 2.0Jul
CPI excluding food, energy, and the effect of changes
in indirect taxes
1.1 1.1 1.4 1.2 1.4 1.4 1.4 1.6 1.9Jul
CPIW 1.7 1.8 1.7 1.7 1.9 1.8 1.8 1.8 1.5Jul
Updated: 06 September 2006
Next update: 19 October 2006
MD Siyam Hossain

16. Unemployment
Bank of Canada web site
Labour market 20
04
Q3
20
04
Q4
20
05
Q1
20
05
Q2
20
05
Q3
20
05
Q4
20
06
Q1
20
06
Q2
20
06
Q
3
Latest
data
Unemployment rate (%) 7.1 7.1 7.0 6.8 6.8 6.5 6.4 6.2 6.4Jul
Participation rate (%) 67.
4
67.
5
67.
3
67.
2
67.
1
67.
1
67.
1
67.
2
67.3Jul
Growth in employment (annualized rate, %) 0.6 1.4 0.9 1.7 1.5 2.4 1.6 3.1 -0.0Jul (1)
Skilled labour shortage (% firms) - Manufacturing (Statscan survey) 7.0 7.0 5.0 7.0 8.0 9.0 6.0 8.0 9.0Q3
Labour shortage (% firms) - All sectors (Bank of Canada Regional Office
Survey)
44.0 36.0 33.0 36.0 51.0 49.0 44.0 27.
0
27.0Q2
MD Siyam Hossain

17. Conclusion
 Two choices – fight inflation or fight recession
 Bank of Canada chose to fight inflation
 It worked, but slowly.
 Current policy – 2% inflation (1-3%)
 Economics is evolving
MD Siyam Hossain

18. References
 McConnell, Brue, and Barbiero. Macroeconomics, 8th
Canadian Ed. 1999, McGraw-
Hill Ryerson.
 Lovewell. Understanding Economics: A Contemporary Perspective, 3rd
Ed.2005,
McGraw-Hill Ryerson.
 http://www.sfu.ca/~grubel/_private/CSV%20Monetary%20and%20Exchange%20Rate%20Po
 http://www.chass.utoronto.ca/~echist/lec15.htm
 http://www.mapleleafweb.com/features/economy/bank_canada/role.html
 www.bankofcanada.ca/en/speeches/2005/sp05-18.html
MD Siyam Hossain