1970s Stagflation

Karl Smith, Scott Sumner, and Yichuan Wang have been discussing whether the experience of the 1970s qualifies as “stagflation.” The term stagflation seems to have been coined in the 1973-74 recession, which was characterized by a rising inflation rate and a rising unemployment rate, a paradoxical conjunction of events for which economic theory did not seem to have a ready explanation. Scott observed that inasmuch as average real GDP growth over the decade was a quite respectable 3.2%, applying the term “stagflation” to the decade seems to be misplaced. Karl Smith says that although real GDP growth was fairly strong unemployment rates were much higher after the early 1970s than they had been in the 1960s and even in the lackluster 1950s (a decade of low inflation and low growth). Yichuan Wang weighs in with the observation that high growth in GDP produced almost no measurable effect on real GDP growth even though a simple Phillips Curve or AD/AS framework would suggest that all that extra growth in nominal GDP should have produced some payoff in added real GDP growth.

Here are some further observations on what happened in the 1970s. Inflation expectations began increasing in the late 1960s, so that a very modest tightening of monetary policy in 1969-70 produced a minor recession, but an almost imperceptible reduction in inflation. Nixon, not wanting to run for reelection with a stagnating economy — the memory of running unsuccessfully for President in 1960 during a recession having seared in his consciousness — forced an unwilling Fed to increase money growth rapidly while cynically imposing wage and price controls to keep a lid on inflation. The political strategy was a smashing success, but the stage was set for a ratcheting up of inflation and inflation expectations, though markets were actually slow to anticipate the rapid rise in inflation that followed.

Thus, the early part of the decade fits in well with Scott’s interpretation. Rising aggregate demand produced rising inflation and rising real GDP growth. Unfortunately, wage and price control quickly began to have harmful economic effects, producing shortages and other disruptions in economic activity that may have shaved a few percentage points off real GDP growth over the next few years. More serious was the first big oil-price shock in late 1973 in the wake of the Yom Kippur war, causing a quadrupling of oil prices over a period of a few months as well as horrific gasoline shortages attributable to the effects of remaining price controls on the petroleum sector, controls that, for political reasons, could not be removed even though other price controls had mercifully been allowed to expire. So in 1974, there was a rapid increase in inflation expectations fueled both by a tardy realization of the inflationary implications of the Nixon/Burns monetary policy of 1971-73, and a presumption that increases in oil prices would be accommodated in output prices rather than prices of complementary inputs being forced down. But because of general anti-inflation sentiment, monetary policy was tightened at precisely the moment when aggregate supply was contracting as a result of rising inflation expectations and an exogenous oil-price shock. That meant that real GDP began falling sharply even while output-price inflation was accelerating. It was that temporary conjunction of falling real GDP, rising unemployment, and rising inflation in 1974 that gave rise to the term “stagflation.” After initially focusing on inflation, the newly installed Ford administration quickly pivoted and provided economic stimulus to generate a recovery and the temporary inflationary bulge worked its way through the system. The recovery was robust enough to have enabled Ford to have been re-elected but for Ford’s monumental gaffe in his debate against Jimmy Carter, denying that Poland was under Soviet domination, and for lingering resentment against Ford from his pre-emptive pardon of Richard Nixon for any crimes that he committed during his Presidency.

By the time that Jimmy Carter took office, the US economy was well into a cyclical expansion, but Carter, after replacing Arthur Burns as Fed chairman with the clueless G. William Miller, encouraged Miller to continue a policy of rapid monetary expansion, producing rising inflation in 1977 and 1978. Once again, excess monetary stimulus produced rising inflation and rising inflation expectations just before a second oil-price shock, precipitated by the Iranian Revolution, began in 1979. The combination of rising inflation expectations and rapidly rising oil prices (exacerbated by the continuing controls on petroleum pricing causing renewed shortages of gasoline and other refined products) induced a leftward shift in aggregate supply, causing inflation to rise while output fell. Hence the second episode of stagflation.

So what does this all mean? Well, if one looks at the periods of rapid increases in aggregate demand in which oil price shocks were absent, we observe very high rates of real GDP growth. In the 1960s from the third quarter of 1961 to the third quarter of 1969, real GDP growth averaged 4.8%. Over the same period, the average annual rate of increase in the GDP price deflator was 2.6%. For the 10 quarters from the first quarter of 1971 through the second quarter of 1973, real GDP growth averaged 5.9%, and for 15 quarters from the second quarter of 1975 to the fourth quarter of 1978, real GDP growth averaged 5.1%. The average annual rate of increase in the GDP deflator in the 1971-73 period was 5.2% and in the 1975-78 period, the rate of increase in prices was 6.4%. In the periods of recession or slow growth associated with the oil-price shocks (i.e, 1973-74 and 1979, the rate of increase in the GDP deflator was 9.3% in the former period, and 8.4% in the latter. Thus inflation was higher in recession or slow growth periods than in rapid growth periods. That was stagflation.  Although economic expansions were about as fast in the 1970s as the 1960s, it would not be outlandish to suggest that rapid increases in nominal GDP in the 1970s did produce faster real GDP growth than would have occurred otherwise, though one might also argue that those temporary increases in real GDP growth had a non-trivial downside.

Why was unemployment so much higher in the 1970s than in the 1960s even though the rate of labor force participation was higher? I think that the obvious answer is that there was an influx of women and baby boomers into the work force without much previous work experience. Typically, new entrants into the labor force spend more time searching for employment than workers with previous experience, so it would not be surprising to observe a higher measured unemployment rate in the 1970s than in the 1960s even though jobs were not harder to find for most of the 1970s than they were in the 1960s.


13 Responses to “1970s Stagflation”

  1. 1 OGT June 18, 2012 at 7:46 pm

    Excellent post. I think it’s pretty well known that Nixon/Burns unmoored inflationary expectations at precisely the wrong time. I was less aware of Carter’s contribution, especially given his subsequent appointment of Volker.

    The Fed’s independence seemed to have significantly less robust then. Whether that’s a good thing is somewhat debatable given the current Fed’s performance.


  2. 2 W. Peden June 19, 2012 at 4:37 am

    Good overview. An etymological note: the creation of the word ‘stagflation’ is generally attributed to Iain Macleod, who was the UK Chancellor for about a month before his death in 1970. As he said in 1965-

    “We now have the worst of both worlds—not just inflation on the one side or stagnation on the other, but both of them together. We have a sort of ‘stagflation’ situation. And history, in modern terms, is indeed being made.”

    It is often said that, had Macleod lived longer, he might have been able to keep British monetary and fiscal policy under control in the early 1970s and avoided the skyrocketing inflation of the mid-1970s. I have my doubts: Peter Thorneycroft tried to do the same thing in the late 1950s and had to resign. Keynesianism was at its peak in Britain during that period; the Bretton Woods restraints were collapsing; “monetarism” was just American mumbo-jumbo; and Hawtrey was one of the classicals who was beaten by Keynes because he had no explanation of unemployment. The pressure to inflate our way to prosperity was immense.

    Compared with what we had in the early 1970s, Nixon and Burns were sages!

    Here’s some footage of Macleod when he was a junior minister in the 1950s, for those of you who were wondering what the man who coined the term ‘stagflation’ was like-


  3. 3 Tas von Gleichen June 19, 2012 at 10:16 am

    That observation still has not changed. There are always jobs, but few have the experience to fill them. None of this employers are willing to train employees. Instead they are looking always for the perfect candidates with lots of experience. This is really unfortunate especially for graduates.


  4. 4 Greg Ransom June 19, 2012 at 1:37 pm

    John Hick abandoned Keynesian economics in 1969-1970 in part because of the British stagflation.


  5. 5 On your Marx June 19, 2012 at 3:14 pm

    I wasn’t aware of a liquidity trap in the UK. Without that Keynes made it clear monetary policy was the tool to use not fiscal policy.

    Money illusion is the clear tool to use to reduce real wages because inflation is necessary after deflation has played havoc.
    I wasn’t aware of deflation being around in the UK either.


  6. 6 W. Peden June 19, 2012 at 11:56 pm

    On your Marx,

    It depends what you mean by ‘liquidity trap’. Paul Krugman alone seems to use it in several different senses: central bank rate drops to near-zero? Liquidity trap. Only unconventional monetary policy is effective? Liquiditiy trap. Monetary policy isn’t effective at all? Liquidity trap.

    One way that Krugman (and modern Keynesians in general) doesn’t use the term ‘liquidity trap’ is the way that Keynes originally meant it, which is a scenario where an increase in the quantity of money cannot reduce the yield on (long-term) government bonds. Is the UK in that scenario? Should we care, given what monetary economists since Keynes from Hawtrey to Nick Rowe have had to say?

    One thing is for sure: the UK economy doesn’t resemble the Japanese economy in any significant sense other than low nominal interest rates and low NGDP growth. That doesn’t stop Krugman reheating advice he gave to the Japanese, albeit with an increased partisan emphasis.


  7. 7 David Pearson June 20, 2012 at 6:52 am

    It seems quite arbitrary to discuss economic growth over a calendar decade. Volker threw the economy into a deep double-dip recession in 1980-1982 to contain inflation. If one skips that fact, then certainly RGDP growth in the 70’s looks better. Take this to an extreme: you can look at RGDP growth achieved through Argentine convertibility and it looks pretty good. After all, this avoids incorporating the cost of abandoning that failed policy.


  8. 8 David Glasner June 20, 2012 at 4:04 pm

    David, I agree. You really have to compare comparable periods, and periods are rarely comparable. The point I was most interested in explaining was why the term “stagflation” was applicable to the 1970s. as a whole mostly on the basis of two periods of negative supply shocks associated with very rapid rises in oil prices.


  9. 9 On your Marx June 21, 2012 at 3:39 pm

    Mr Peden,

    Thanks for that but it seems to me ( I don’t agree Krugman has several versions),It is simply when monetary policy doesn’t work and it patently did in the 1970s.
    I fail to see how Keynesianism had anything to do with Stagflation unless you subscribe to the fact most governments were not stern enough in the good times.

    Keynesianism is much sterner than classical economics in good times (as fiscal policy should be).


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About Me

David Glasner
Washington, DC

I am an economist in the Washington DC area. My research and writing has been mostly on monetary economics and policy and the history of economics. In my book Free Banking and Monetary Reform, I argued for a non-Monetarist non-Keynesian approach to monetary policy, based on a theory of a competitive supply of money. Over the years, I have become increasingly impressed by the similarities between my approach and that of R. G. Hawtrey and hope to bring Hawtrey’s unduly neglected contributions to the attention of a wider audience.

My new book Studies in the History of Monetary Theory: Controversies and Clarifications has been published by Palgrave Macmillan

Follow me on Twitter @david_glasner


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