Inflation tripled in 1973, rising from 3.4% to 9.6%. It remained between 10-12% from February 1974 through April 1975. (Source: BLS, Chart of 1970-1979 Inflation)
When the economy is working normally, stagnant economic growth reduces demand, which keeps prices low, preventing inflation. Stagflation can only occur when fiscal or monetary policy sustains high prices, and inflation, despite slow growth.
Stagflation is normally blamed on the oil supply shocks of 1973, when OPEC cut its quota and prices quadrupled. However, several other shocks occurred:
- The U.S. went off the gold standard (Bretton Woods Agreement), which increased the money supply. This created inflation, as too many dollars chased too few goods.
- As prices rose, demand fell, and businesses cut back on production.
- However, the effect of the sudden surplus of dollars kept an upward pressure on prices even after the economy became sluggish. Ultimately, inflation rose to double digits.
- President Nixon instituted wage and price controls, throwing off the ability of the markets to self-correct.
- To fight inflation, the Fed kept raising the Fed Funds rate, reaching a peak of 20% in 1979. However, it did so in a "stop-go" fashion, confusing price-setters, many of whom kept prices high.
Can stagflation reoccur? Yes, in response to sudden increases in global liquidity, but probably not to the same extent. That's because both stop-go monetary policies and wage-price controls have been discarded.
