B1 Intermediate US 1153 Folder Collection
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OK, so what caused stagflation?
This is an important question.
It's an important question because the answers people gave in the 1970s
and afterwards helped to set that paradigm I was talking about before.
And a paradigm is, in fact, a set of questions and the answers
that answer those questions, right?
Those things fit together.
So it tells us what to look at as problems,
and it tells us what to use as solutions.
And coming out of the 1970s, one really dominant powerful paradigm
said that the cause of stagflation was too much social
spending leading to high deficits.
Those high deficits would crowd out private investment,
discourage investment, pushing up interest rates.
So, thus, you could get high inflation at the same time as high interest
rates.
You could get high inflation in recession.
But, in fact, there is not only a political motivation to that argument,
but there's an empirical problem with that argument.
If you look at the actual history of the 1970s, the big episodes of inflation--
and it's obvious on graphs-- are tagged directly to oil price shocks.
Now, what's a price shock?
A price shock is when a key resource or commodity rises dramatically, rapidly,
in price.
And because that commodity is so important, just as oil was.
Oil was everywhere in the American economy in the 1970s.
Because it's so important, that pushes up all other prices
and causes a lot of disruption, dislocation, and uncertainty
in the economy.
And you can see from the graphs that this is exactly what happened.
In 1973, when OPEC embargoes oil to the United States,
stops oil flowing to the United States, it
pushes up the domestic price of gas 400%.
Americans wait by the millions in lines to get their gas.
They often can't get gas on several days of the week.
There are all kinds of regulations put in place.
Uncertainty is their response.
Many of them turn and invest in smaller cars,
which necessitates more spending, pushing up inflation.
But in general, prices rise throughout the economy.
And the same thing happens again in 1979 and 1980
when Jimmy Carter encounters his biggest foreign policy
crisis-- the Iran hostage crisis, which cuts off
a major source of oil to the American economy, pushes up prices again.
And people react to that, in part because
of the memory of what happened in 1973 and '74.
They start to push up prices and panic.
So those episodes of high inflation are caused by many things,
but oil price shocks are crucial.
This doesn't mean that they would have happened if a different policy had been
followed, or this policy versus that policy had been followed.
But what it does mean is that when we think
about the argument that high deficits or high social spending
is always bad and is always going to lead to inflation
and is always going to lead to rising interest rates,
we should probably look at cases where oil price shocks are not in the mix.
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What Causes Stagflation?

1153 Folder Collection
James published on June 26, 2015
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