Notes on the Great Inflation of the 1970s

Introduction

• The lecture discusses inflation and unemployment during the Carter presidency, highlighting the economic challenges faced during this time.
• Purpose: To explore the causes of the Great Inflation of the 1970s.

Overview of the Great Inflation

• Definition: A significant macroeconomic event in the second half of the 20th century.
• Duration: 1965 to 1982; included four economic recessions, energy shortages, and wage/price controls.
• Resulted in a rethinking of Federal Reserve policies.
• Considered a major failure of American macroeconomic policy post-World War II.

The Rise of Inflation

• Inflation Rates:
  • 1964: ~1%
  • 1980: peaked at over 14%
  • 1980s: Fell to ~3.5%
• Main cause: Excessive money supply growth due to Federal Reserve policies.

Forensic Examination of the Great Inflation

1. Motives

• Phillips Curve: The belief in a stable inverse relationship between inflation and unemployment.
• Disproved during the 1970s due to simultaneous high inflation and unemployment (e.g., 8.2% unemployment).
• Historical Context:
  • Post-Great Depression macroeconomic policy transformation.
  • Employment Act of 1946: Established federal responsibility for maximum employment and stable prices.

2. Means

• Collapse of Bretton Woods: Separation of the U.S. dollar from gold.
• Increased global demand for U.S. dollars led to monetary instability.
• Nixon's 1971 decision to suspend dollar convertibility into gold marked the beginning of the dollar's decline.

3. Opportunities

• Fiscal Imbalances & Energy Crises:
  • Major spending programs (e.g., Great Society) and Vietnam War increased fiscal strain.
  • Arab Oil Embargo (1973) and Iranian Revolution (1979) led to quadrupled and tripled oil prices, respectively.
• Mismanagement of monetary policy exacerbated inflation.

Types of Inflation

• Demand-Pull Inflation: Caused by excessive government spending and monetary policy.
• Cost-Push Inflation: Driven by supply disruptions (e.g., energy crises).

Impact of Inflation on Employment

• Policymakers faced a trade-off between controlling inflation and maintaining employment.
• Paul Volcker's Leadership:
  • Appointed chairman of the Federal Reserve in 1979.
  • Shifted focus to controlling money supply to combat inflation.
  • Higher interest rates led to increased unemployment initially, but inflation was ultimately reduced.

Conclusion and Lessons Learned

• Current monetary policies emphasize the importance of price stability and controlling inflation.
• Economic policies have real-world consequences; vigilance on inflation is necessary.
• Central bank power must be balanced to avoid repeating past mistakes.