Stagflation

Stagflation

• If the government and central bank do not step in the aggregate

  supply

  ---

  will shift

  right

  ---

  in the long run the economy will go from B to point

  A

  ---

  . The risk is that sometimes there will be a wage spiral (which is when wages and price level keep rising) and it can take a long time to return to the natural output.
• If the government and central bank step in the aggregate

  demand

  ---

  will shift

  right

  ---

  and the economy will go from B to point

  C

  ---

  . The output will return to the natural level but the inflation will go

  even higher

  ---

  .