Often in commentary about the pending impact of Value Added Tax (VAT) on the Bahamian economy, the term "Stagflation" is used to describe the resulting consequences from such a policy.. It sounds like a rather frightening term and that very well is true as VAT will lead to rather harmful and adverse economic outcomes.. This is so because the undesirable economic consequences resulting from a VAT policy leads to an economy characterized by Stagflation..
An economy that declines into a state of Stagflation is characterized by three specific economic criteria.. Firstly, the aggregate rate of inflation increases as traditional economic tools of fiscal and monetary policy seem to be ineffective.. Secondly, economic growth grinds to a standstill or a snail's pace.. This no growth stagnated environment should retard the rate of inflation, but it doesn't slow spiralling inflation as Keynesian economic theory would suggest.. Thirdly, unemployment continues to increase as firms adjust to a high inflation, no growth economic environment.. These three economic factors combine to create economic stagnation known in economics as Stagflation..
As we might presume, Stagflation is a most undesirable state for a country to find itself in and is a most difficult position to get itself out of as traditional Keynesian economic policies are not very effective.. Up until the the late 1980's, Keynesian trained economists accepted the Phillips Curve as an economic given where there is a historical inverse relationship between unemployment and rates of inflation.. To reduce rising unemployment, government economic planners have to accept a given increase in the aggregate rates of inflation.. This became a fundamental underlying assumption as economists attempted to fine-tune future economic performance.. All was well until the United States in the 1970's fell into a prolonged recession (stagnated growth) in which unprecedented rates of inflation continued to increase..
Under Keynesian theory this should not happen, but in actuality it was exactly what happening as Phillips Curve tradeoffs proved to be ineffectual as both real unemployment and inflation rates rose rapidly together.. It was not until Supply-Side tax decreases and eventual more accommodative monetary policies overcame this period of what many described today as Stagflation..
For more venturesome minds, the left-leaning journalist William Greider's book, "Secrets of the Temple, How the Federal Reserve runs the Country", is powerful reading of how President Reagan and Fed Chairman Paul Volcker pursued contradictory economic goals creating eventually one of the country's strongest economic recoveries.. What is most amazing is that the underlying strength of the American economy was able to overcome this period of Stagflation through the adoption of Supply-Side fiscal policies.. Keynesian tax and spend economics had failed and were trumped and defeated by Supply-Side (tax cutting) economics which was a return to the traditional focus of classical economists on the supply side of equilibrium determination..
Other examples of contemporary uncontrollable Stagflation include Japan, the third largest economy in the world, that collapsed into a state of Stagflation which has lasted for over two decades.. Another is Zimbabwe, which prior to its independence, was the second wealthiest country in Africa.. Four years later, it was one of the poorest with no hope for economic recovery..
Perhaps what must be recognized is that once dreaded Stagflation takes hold, it is extremely difficult for most governments to engineer a sustainable economic recovery.. A closer look at the nation's of Europe will disclose many of the frightening economic symptoms leading to Stagflation..
The lessons of economic experience for our Bahamas are more than clear.. The clouds of recession, leading ultimately to dreaded stagflation, are forming as the titanic hurricane of government imposed VAT approaches to what will become a day of economic reckoning.. Once this terrible storm hits our fragile economy, its destructive forces will possibly collapse our economy to a state where it will take perhaps many years of economic pain to restructure and bring about meaningful economy recovery..
The combination of stagnant growth and hyper-inflation resulting from VAT must be avoided at all costs.. Stagflation is like an economic paralysis where the economy is put on life support and then the power goes out..
Stagflation is not an inevitable outcome and can be avoided by prudent economic thinking when government has the necessary will power and understanding..