125 Reading: Overheating and Stagflation

Overheating and Stagflation

There are a couple helpful vocabulary terms to understand related to the states of the economy.

Overheating means the economy is picking up speed leading to increased inflation. It occurs when its productive capacity is unable to keep pace with growing aggregate demand. It is generally characterized by an above-trend rate of economic growth, where growth is occurring at an unsustainable rate. Boom periods are often characterized by overheating in the economy.

Stagflation means the simultaneous occurrence of stagnant growth (or recession) and inflation, something the Keynesian economists thought to be impossible, but you can show it with AD/AS. It is a situation where the inflation rate is high, the economic growth rate slows down, and unemployment is also high. It raises a dilemma for economic policy since actions designed to lower inflation may exacerbate unemployment, and vice versa.