Debunking a cherished myth: The 1970´s was not the “stagflationary decade”.

In a recent post provocatively entitled “In praise of stagflation” Scott Sumner writes:

In one of yesterday’s posts I pointed out that we can’t trust any of the economic history that we learned in school–citing the 1929 stock market crash (which actually had no impact on the economy.)  Another example is that “decade of stagflation;” the 1970s.  The only problem with this commonly held view is that the 1970s were not a decade of stagflation; rather we saw an extraordinary surge in aggregate demand:

NGDP growth averaged:  10.4%

RGDP growth averaged:   3.2%

Growth was normal, and inflation was very high.  Rapid growth in AD explains roughly 100% of the inflation during the 1970s.  There was no stagflation, just inflation.

Now a purist can find a few individual years of stagflation, such as 1974.  This occurred for two reasons.  OPEC sharply cut oil output in late 1973, which was a severe real shock to the economy.  And price controls were being phased out, meaning that part of the measured inflation of 1974 actually occurred in 1972-73, but was covered up to facilitate Richard Nixon’s re-election.  (Actually that’s not quite fair—in those days many of the best and the brightest progressive economists supported wage-price controls.)

So the “stagflationary 1970s” is a big myth.

That myth springs from the popular view that it was the rise in oil prices that caused the rise in inflation. Quite likely it was not so. The chart shows that while inflation had picked up from the mid-1960s, oil prices were “stuck” at about $3 to $3.50 a barrel. Naturally, oil producers were a bit peeved about the reduction in their real incomes and decided to do something about it. In addition, as Scott claims, part of the steep rise in inflation was due to the undoing of price controls.

But it was a supply shock anyway. And the economy reacted as indicated by a regular AS-AD model. The chart below shows that aggregate demand (AD) was on a rising trend over the decade, while real output growth averaged about 3.2% a year. The fact that turned the 1970´s into the “inflation decade” was the systematic increase in nominal spending to compensate for the negative effects of the shocks on unemployment and RGDP growth.

A longer term view brings out clearly what went on with real output growth and inflation during the different nominal spending growth “regimes”. It clearly indicates the advantages of stabilizing nominal spending – or aggregate demand – growth along a defined level path.

Advertisements

7 thoughts on “Debunking a cherished myth: The 1970´s was not the “stagflationary decade”.

  1. I’m more inclined to believe the inflation was due to many of us baby boomers using credit for the first time. In many cases, our parents hardly used credit at all and even built homes with cash.

  2. It’s really interesting to think about the growing use of credit in the entire system. Certainly everyone learned to manage it through the Great Moderation. But you’re right, the growing use of credit is in part responsible for creditism thinking today. I’m glad I’m old enough to remember when life was possible without credit!

    • Luis – The oil producing countries were the ‘fall guys’ for Burns´ incompetence. For most of that time real output evolved close to potential so that ‘cranking up’ the spending engine only resulted in higher inflation.

  3. Pingback: Debunking a cherished myth: The 1970´s was not the “stagflationary decade”. « Economics Info

  4. Pingback: Advocates of Reason: 25 June 2012 | Economic Thought

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s