EcoWeek

Which insights from the ‘great inflation’ of the 1970s?

Eco week 21-18 // 10 May 2021  
economic-research.bnpparibas.com  
2
EDITORIAL  
UNITED STATES: WHICH INSIGHTS FROM THE ‘GREAT INFLATION’ OF THE 1970S?  
The ‘great inflation’ of the 1970s had many causes. The policy objective of full employment had already led to high inflation  
by the end of the 1960s. Two oil shocks and the depreciation of the dollar caused additional increases. The key factor was  
monetary policy, which was not adapted to the circumstances. It reflected the view that the Fed did not have a mandate  
to tolerate the sizeable increase in unemployment that might have ensued from the aggressive tightening needed to bring  
inflation under control. In addition, inflation was considered to be a cost-push phenomenon that could be addressed  
with wage and price controls. Today’s situation is very different. The Federal Reserve is an independent central bank  
and inflation expectations are well-anchored. However, letting the economy run hot is reminiscent of the 1960s. Should  
inflation be above target for too long, the Federal Reserve will need to have the courage to tighten policy sufficiently  
despite the potential cost to the economy.  
Other goals took precedence: people wanted to […] maintain a high- Supply shocks played an important role in the 1970s. The narrative  
pressure economy… As a result, policymakers […] were willing to run of inflation in that period tends to focus on the two huge, permanent  
some risk of non-declining or increasing inflation in order to achieve increases in the price of oil, triggering a jump in inflation (chart 1).  
other goals.” When, at the annual Jackson Hole symposium in August The depreciation of the dollar following the collapse in 1973 of the  
last year, Jerome Powell presented the move to average inflation Bretton Woods system of fixed exchange rates centered around the  
targeting as a key outcome of the Federal Reserve’s strategy review, dollar and gold, also contributed to a faster pace of price increases  
4
it was interpreted as a signal that the central bank was seeking to let (chart 2) . However, inflation was already on a rising trend, well before  
the economy run hot. Reaching a low unemployment rate would only these shocks hit the US economy. In the first half of the 1960s, headline  
trigger a tighter policy stance to the extent that inflation would be inflation was below 2% but by the end of that decade, it was close to  
above the target rate for a sufficiently long time. Yet, the quote above 6.0% (chart 3). DeLong (1997) explains how the prominent role of the  
is not from 2020. It is from an academic analysis written in 1997 of the narrative of the Great Depression and its high unemployment rate had  
1
causes of the ‘great inflation’ in the 1970s. The narrative of a bygone made achieving a low unemployment level the key objective of economic  
era can influence the debate on economic policy many years later. This  
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. The Bretton Woods system already had been under intense pressure in 1971 following  
is clearly the case today where in the US, based on a combination  
of strongly accelerating growth, mounting evidence of inflationary  
pressures and ongoing monetary and fiscal stimulus, increasingly  
references are made to the 1970s. Commenting on Jerome Powell’s  
assessment that higher inflation will be a temporary phenomenon,  
former Treasury secretary Larry Summers argued “He might be right.  
But the Fed chairmen who did the most talking about transitory  
factors were the Fed chairmen we had in the mid-70’s and that’s when  
the unilateral decision of the US administration on 15 August 1971 to end the convertibility  
of US dollars into gold.  
US: INFLATION VS CRUDE OIL PRICE  
Headline inflation, y/y %  
WTI crude oil spot price, USD/bbl (RHS)  
2
inflation was accelerating very rapidly”. Nouriel Roubini, a professor  
14  
35  
30  
25  
20  
15  
10  
5
at New York University and renowned economic commentator, focuses  
on the combination of inflation risks and potential negative supply  
shocks related to the Covid-19 pandemic that could end up causing  
1
2
10  
8
1
970s-style stagflation.3  
6
1
.
J. Bradford DeLong, America’s Peacetime Inflation: The 1970s, in Reducing Inflation:  
Motivation and Strategy, Christina D. Romer and David H. Romer, Editors, NBER, University  
of Chicago Press, 1997. http://www.nber.org/books/rome97-1. The full quote is: “Other goals  
took precedence: people wanted to solve the energy crisis, or maintain a high-pressure  
economy, or make certain that the current recession did not get any worse. As a result,  
policymakers throughout the 1970s were willing to run some risk of nondeclining or  
increasing inflation in order to achieve other goals.”  
4
2
recession periods  
74 75 76  
0
0
70  
71  
72  
73  
77  
78  
79  
2
.
Summers sees signs of scarce workers as harbinger of inflation, Bloomberg, 30 April  
021.  
. Nouriel Roubini, Is Stagflation Coming?, 14 April 2021, Project Syndicate.  
2
CHART 1  
SOURCE: BLS, FEDERAL RESERVE BANK OF ST LOUIS, NBER, BNP PARIBAS  
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The willingness of the Federal Reserve to let the economy run hot is  
reminiscent of the 1960s when a similar policy paved the way for high  
inflation in the 1970s. Although today’s situation is very different, the  
Federal Reserve will, if necessary, need to have the courage to tighten  
policy sufficiently despite the potential cost to the economy.  
The bank  
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world  
Eco week 21-18 // 10 May 2021  
economic-research.bnpparibas.com  
3
policy. This was particularly the case under Richard Nixon, who became  
president in January 1969 and “was extremely wary of economic policies  
US: INFLATION VS EFFECTIVE EXCHANGE RATE  
5
that promised to fight inflation by increasing unemployment.” Rising  
Core inflation, y/y %  
USD nominal effective exchange rate, January 1970=100 (RHS)  
105  
inflation caused an acceleration of wage growth, which in turn pushed  
up inflation considering that productivity growth was slowing. Moreover,  
an “obstacle to a policy of disinflation in the early 1970s was that the  
newly installed chairman of the Federal Reserve Board, Arthur Bums,  
did not believe that he could use monetary policy to control inflation.”6  
This reflected a view that bringing down inflation permanently would  
come at a huge cost in terms of unemployment. The Federal Reserve  
didn’t have the mandate for such a policy. Its “’independence’ not just  
from the executive branch, but from the rest of government in total,  
was purely theoretical”. Policy was tightened but, compared to the path  
of inflation, the increase in the federal funds rate was insufficient (chart  
1
1
2
0
8
6
4
2
0
100  
95  
90  
4
). Another consideration was that other instruments should be used to  
recession periods  
74 75 76  
85  
bring inflation under control, such as wage and price controls. This view  
reflects the ‘monetary policy neglect hypothesis’ whereby inflation is a  
7
0
71  
72  
73  
77  
78  
79  
7
CHART 2  
cost-push phenomenon, rather than being driven by monetary factors .  
SOURCE: BLS, NBER, JP MORGAN, BNP PARIBAS  
However, wage and price controls made things worse by creating  
expectations of a jump in inflation once the controls would be lifted.  
US INFLATION  
Core inflation, y/y % Headline inflation, y/y %  
In summary, the ‘great inflation’ of the 1970s can be attributed to a  
combination of factors. The policy objective of low unemployment  
had already led to high inflation even before the decade had started.  
Two oil shocks and the depreciation of the dollar caused an additional  
increase. Monetary policy was inappropriate and reflected the view  
that the Fed did not have a mandate to tolerate the sizeable increase  
in unemployment that might have ensued from the aggressive policy  
tightening needed to bring inflation under control. In addition, inflation  
was considered as a cost-push phenomenon that could be addressed  
with wage and price controls. Today’s situation is very different. The  
Federal Reserve is an independent central bank with, as one of its  
objectives, price stability, which means average inflation in line with  
its target. Inflation expectations are well-anchored, which shows that  
its policy is credible. Letting the economy run hot is reminiscent of the  
15  
1
2
9
6
3
0
3
recession periods  
0 63 66 69 72 75 78 81 84 87 90 93 96 99 02 05 08 11 14 17 20  
-
6
1
960s although today it is based on the view that the natural rate of  
unemployment can’t be determined with enough precision to warrant  
a preemptive monetary tightening when unemployment is declining. It  
implies that, should inflation be above target for too long, the Federal  
Reserve will need to have the courage to tighten policy despite the  
potential cost for financial markets, public finances and the economy  
in general.  
CHART 3  
SOURCE: BLS, NBER, BNP PARIBAS  
US: INFLATION VS INTEREST RATE  
Headline inflation, y/y %  
Effective Fed Funds rate, monthly average  
T. Note 10-y rate, monthly average  
William De Vijlder  
1
1
1
1
6
4
2
0
8
6
4
2
0
recession periods  
6
0 61 62 63 64 65 66 67 68 69 70 71 72 73 74 75 76 77 78 79  
CHART 4  
SOURCE: BLS, FEDERAL RESERVE, NBER, BNP PARIBAS  
5
.
DeLong (1997).  
. DeLong (1997).  
.
6
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Edward Nelson, The Great Inflation of the Seventies: What Really Happened?, Federal Reserve Bank of St. Louis Working Paper 2004-001. The author considers this to be the key  
explanation for the great inflation in the seventies.  
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for a changing  
world  
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