What is stagnation?

Stagnation is a term in economics that describes an economy that has little or no growth for a prolonged period. 

According to the European Central Bank’s stagnation definition, it is “a protracted period of low growth and high unemployment”. 

Being in stagnation means that the real economic growth is less than 2% annually. Indicators of stagnation include a decrease in gross domestic output (GDP), an increase in unemployment, reduced job growth, falling or capped wages, and other signs of a weaker economy. 

An example of stagnation is the two decade-long sluggish economic growth in Japan in the early 1990. Another example is the slow recoveries in the US and the eurozone in the aftermath of the 2008 financial crisis.  

Why does stagnation occur?

Stagnation in economics can happen as part of the cycle or as a result of unfavourable events. 

For example, an economy can experience stagnation during a recurring period of lower activity, such as during a holiday season, but the effect of this is brief and the economy will recover quickly. 

Stagnation can also happen in response to unfavourable or uncertain economic conditions, such as when businesses hold back investments to wait for more clarity. 

For example, when emerging economies adopt policies which deter foreign investments, or during a war or when a natural disaster happens economic activity in a country is put on pause. 

However, in a long-term stagnation, also known as secular stagnation, the effect on an economy tends to be permanent or long-lasting. 

What are the causes of stagnation?

There are several causes to stagnation, which can be cyclical, structural or due to economic shocks. 

• Cyclical stagnation

Stagnation sometimes occurs for a temporary period as a natural part of an economic or business cycle. 

This could happen during a stalled recovery from a full recession, but this is often cyclical and temporary. 

• Structural stagnation

When stagnation occurs in a stable economy, the effect can be much more permanent.

Advanced economies with slower population growth, stable economic institutions can experience slower growth rates. 

Institutional factors such as entrenched power among incumbents who oppose competition and transparency, can induce economic stagnation.

For example, Western Europe was experiencing economic stagnation because of the excessive regulation, rigid labour market and overly generous welfare policies in the 1970s and 1980s, a period coined as “Eurosclerosis”. 

• Economic shocks 

Economic shocks from external factors can induce periods of stagnation. 

For example, war and famine, or a sudden increase in oil prices or fall in demand for a key export can induce stagnation in an economy. 

Stagnation vs stagflation

Stagnation and stagflation are similar, but the latter is characterised by rising inflation rate in addition to slower economic growth and high unemployment rate.