Sample Solution

low. During 1983 until 1993, the inflation decreased, but unemployment rates were up in most countries, specifically in Western Europe, which credited to hysteresis outcomes and rigidities in the labor market (Guillermo & Rodrigo 2008, 147). In the recent period of 1994-2002, it is obvious that inflation rates were minimal, but unemployment rates have raised in Western Europe and dropped in America. It is only around 1973-1983 that high inflation and high unemployment rates were recorded instantaneously. This was described as stagflation. According to Keynesianism criticizers stagflation was an inevitable inheritance of demand management policies associated with Keynesian economics (Baumol and Blinder, 2006)
Economists emphasize that there are two principal reasons of stagflation. First, a negative supply shock can decrease the productive ability of an economy. Examples of unfavorable shocks involve a raise in oil prices for an importing nation. Such shocks have an inclination of raising prices and slowing down the economy by the increasing costs of production and reducing lucrativeness at the same time (Guillermo & Rodrigo 2008). The second plausible cause of stagnation is inappropriate macroeconomic strategies. For example, letting an extreme growth in the supply of currency can escalate inflation, and the government can generate stagnation by using intense regulation of goods and the labor market. These two aspects performed an important role in triggering the 1970s worldwide stagflation that led to the fall of Keynesian economics. The stagflation began with huge increases in oil prices and continued, because central banks used the intense simulative monetary policy to solve the recession. The fall of Keynesianism also credited to the fact that many economists did not take into account the probability of stagflation (Blinder, 2013). Historical data pointed out that high unemployment rates were related with low inflation rates and vice versa, as shown in the Phillips curve (Khan Academy, 2017). The theory was that a high demand for goods increased prices, which in turn stimulated companies to employ more people. Likewise, high employment rates augmented demand. During the 1970s stagflation, it became obvious that the link between inflation rates and employment levels was sometimes unstable. As a result, macroeconomists were unconvinced about Keynesianism, eventually steering to the end of the impact of Keynesian theories in economic strategies. Monetarist economists, such as Edmund Phelps and Milton Friedman clarified a shift in the Phillips curve: they maintained that when companies and workers anticipated high inflation, there was a shifting up of the Phillips curve, suggesting that high inflation can occur at any rate of unemployment (Khan Academy, 2017). Unambiguously, they argued that if inflation remained high for many years, workers and companies would begin emphasizing its consequences during wage negotiations, causing in a quick increase of earnings and firms’ prices, which further quickened inflation. This enlightenment was an extreme cas