Final answer:
Stagflation is an economic condition characterized by high inflation and high unemployment, which does not align with traditional Keynesian theory that suggests an inverse relationship between the two.
Step-by-step explanation:
Stagflation is a combination of recession and inflation. It is characterized by a unique situation where the economy experiences high unemployment and high inflation simultaneously. This economic phenomenon challenges traditional economic theories, such as Keynesian economics, which generally posit that inflation and unemployment have an inverse relationship.
Historical instances of stagflation in the United States occurred in the mid-1970s and the early 1980s, particularly noticeable during the deep recession from 1973 to 1975 and the back-to-back recessions from 1980 to 1982. Supply shocks, such as the oil crisis in the mid-1970s, and changes in inflationary expectations are key factors that can lead to stagflation. These factors cause shifts in the aggregate supply curve, which in turn affect the general price level and unemployment rates.
In an economic setting, when aggregate demand decreases, or shifts in aggregate demand do not keep pace with increases in aggregate supply, inflationary pressures may build up leading to heightened price levels. Hence, stagflation refutes the traditional Phillips curve concept, which suggested a stable trade-off between inflation and unemployment. During periods of stagflation, the government might employ fiscal policy to address economic imbalances.