Deja Vu: Unraveling the Inflation Puzzle of the 1970s

he 1970s were marked by a period of high inflation, which had a significant impact on the global economy. This era of soaring prices, often referred to as the “Great Inflation,” left lasting effects on economic policy and public perceptions of inflation. Understanding the causes of this inflationary episode is essential for preventing a recurrence of such destabilizing events in the future. This blog post will delve into the key factors that contributed to the inflation of the 1970s, the consequences of this economic phenomenon, and the lessons learned from this tumultuous period.

I. Oil Price Shocks: The Emergence of Energy Crises

The 1973 Oil Crisis

• The Yom Kippur War and the OAPEC embargo
• The quadrupling of oil prices
• Effects on production costs and consumer prices

The 1979 Oil Crisis

• The Iranian Revolution and its impact on oil production
• The subsequent spike in oil prices
• The pervasive influence of oil price shocks on inflation

II. Expansionary Monetary Policy: Fueling Inflation

The Keynesian Framework

• The influence of Keynesian economics on monetary policy
• The focus on government intervention and managing aggregate demand

The Federal Reserve’s Expansionary Policy

• Lower interest rates and increased money supply
• The pursuit of economic growth and combating unemployment
• The unintended consequences of inflation

III. The Wage-Price Spiral: A Vicious Cycle

Workers and Rising Living Costs

• The demand for higher wages to cope with inflation
• The influence of labor unions in pushing for wage increases

Employers and Production Costs

• The impact of wage increases on production costs
• The transmission of higher costs to consumers
• The feedback loop of the wage-price spiral

IV. Fiscal Policy: Government Spending and Budget Deficits

Expansionary Fiscal Policies

• Increased spending on social programs and the Vietnam War
• The resulting budget deficits and their impact on inflation

The Role of Expectations

• The public’s anticipation of continued government spending
• The self-fulfilling prophecy of inflationary expectations

V. Declining Productivity Growth: A Struggling Economy

The Slowdown in Productivity

• Factors contributing to reduced productivity growth
• The inability of the economy to absorb increased costs

The Implications for Inflation

• The relationship between productivity growth and inflation
• The exacerbation of inflationary pressures

VI. The Aftermath: Taming Inflation and Lessons Learned

The Volcker Revolution

• The appointment of Paul Volcker as Federal Reserve Chairman
• The implementation of tight monetary policy to combat inflation
• The short-term pain for long-term gain

The Shift in Economic Paradigms

• The decline of Keynesianism and the rise of monetarism
• The renewed focus on controlling inflation

Lessons Learned from the 1970s

• The importance of monetary policy in managing inflation
• The need for fiscal discipline and sustainable government spending
• The significance of productivity growth for economic stability

The inflation of the 1970s was a complex and multifaceted phenomenon, resulting from a combination of factors, including oil price shocks, expansionary monetary policy, a wage-price spiral, fiscal policy, and declining productivity growth. These factors interacted to create a period of high inflation that reshaped the global economic landscape.

The experiences of the 1970s offer valuable lessons for policymakers and the public. First, it highlights the importance of a disciplined monetary policy that prioritizes price stability. Second, it underscores the need for prudent fiscal policy, with a focus on sustainable government spending and balanced budgets. Third, it emphasizes the significance of promoting productivity growth as a means of fostering economic stability and resilience.

In the years following the Great Inflation, there was a notable shift in economic paradigms and policymaking. The decline of Keynesianism and the rise of monetarism, as well as a greater emphasis on inflation targeting, helped prevent a recurrence of such high inflation rates. Since then, government has started the same cycle that we went through in the 1970’s.

Despite these lessons, policymakers have since turned back to the same policies that cause the inflation of the 1970’s. This has in turn resulted in the same inflation and raising of the interest rates by the Federal Reserve. By understanding the factors that contributed to the inflation of the past, those who read about the history of economics anticipated this result. Why didn’t the Federal Reserve or the treasury department?