Stagflation

In the mid-70’s, economists were mystified by stagflation. According to the Phillips Curve, it could not happen.

… the U.S. economy was experiencing the phenomenon of ‘stagflation’ – a clearly discernible overturning of the conventional economic wisdom about the tradeoff between inflation and unemployment so neatly expressed in the Phillips curve. So-called ‘Keynesian fine tuning onto the neoclassical track’ was not working; and forms of socialist planning only promised to deepen rather than resolve the anomalies of welfare economics. … (Lonergan) believed he had an explanation for what, in a statement from the essay we are editing, he described as a “situation – sometimes thought mysterious – in which consumer prices continuously inflate, new enterprise is evaded, unemployment becomes chronic, and despite inflation the value of stocks declines.” [CWL 15, Editors Introduction, xli]

All they could do was assert it and describe it with statistics. They could not explain it. Lonergan’s explanation – rather than a mere asserting or postulating – is simply that stagflation is a draining of the surplus circuit accompanied by a flooding of the basic circuit. It doesn’t “result from” the draining. It is the draining. And as such, it is a maladaptation or mismanagement of the economic process.

Just as we explained the boom and slump with reference to the operative circuits’ interaction with the Redistributive Function in the Diagram of Rates of Flow – rather than merely asserted the boom and slump – so we explain stagflation as the disequilibrium or imbalance of the crossovers. It is a dynamic disequilibrium among interdependent flows.

Near the end of CWL 15, in the treatment of the superposed circuit of deficit spending and taxes, Lonergan comments that, “what cannot be tolerated, much less sustained, is for one circuit to be drained by the other.” [CWL 15, 175]

Need the moral be repeated? There exist two distinct circuits, each with its own final market. The equilibrium of the economic process is conditioned by the balance of the two circuits: each must be allowed the possibility of continuity, of basic outlay yielding an equal basic income and surplus outlay yielding an equal surplus income, of basic and surplus income yielding equal basic and surplus expenditure, and of these grounding equivalent basic and surplus outlay. But what cannot be tolerated, much less sustained, is for one circuit to be drained by the other. [CWL 15, 175]

… it will be possible to distinguish stable and unstable combinations and sequences of rates in the three main areas and so gain some insight into the long-standing recurrence of crises in the modern expanding economy. [CWL 15, 53-54]

And McShane provides similar comments in Economics for Everyone.

The other situation, with Z” less that T”, is one which seems more compatible with welfare tendencies. Surplus income , associated with the rich, is taxed more vigorously, while there is an easing of the tax burden on the less well-to-do. Z’ is then the prime outlet for government spending. Z” is small and overall surplus activity is discouraged. There is nothing surprising in a resulting consumer price-inflation, in a failure of enterprise, in a decline in both employment and stock value. [McShane, 2017, 95]