Different economists sought to explain the phenomenon of stagflation differently. Three leading views are given below:

1. Keynesian View:

The Keynesians explain the phenomenon of stagflation in terms of upward shift in Phillips curve. This upward shift in the Phillips curve is caused mainly by various cost-push factors, such as

(a) Increase in the world prices of crude oil;

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(b) Wage increases due to strong trade unions;

(c) Wage increases due to higher cost of living during inflationary period;

(d) Changes in the composition of demand for labour in the dynamic conditions, causing an upward shift in wages; etc.

2. Supply-side View:

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Supply-side economists hold the view that various government actions and regula­tions, which raise cost of production and restrict aggregate supply of goods and services, are responsible for the phenomenon of stagflation.

Higher tax rates, minimum wage legislation, social security measures are some such actions. A higher marginal tax rate for example, induces workers to work less.

The underlying assumption it that the individuals while acting as workers, savers and investors always respond to the changes on the margin.

When the marginal tax rate is raised, it reduces the after-tax pay of the workers, after-tax interest earnings of the savers, and after-tax return of the investors.

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All this will reduce work effort, saving and investment, which, in turn, reduce output and employment, and increase prices.

3. Monetarist View:

According to the monetarists, the phenomenon of stagflation is the result of changes in inflationary expectations. The monetarist view has been explained in the Friedman-Phelps model.

The Friedman-Phelps model states that an expansionary monetary policy can increase employment at the cost of inflation only if the workers do not correctly anticipate the inflation rate. Such a policy to reduce employment is doomed to be a failure.

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It will appear successful only in the short period as long as the government is able to fool labour by maintaining an actual inflation rate greater than that expected by labour.

In the long run, when the labour will correctly anticipate the higher rate of inflation, the unemployment rate will return to its natural level.

Thus, in the long period, the expansionary monetary policy will lead to an increase in both the price level and the unemployment rate.