The Recessions of 1970

Stagflation. Not a positive sounding term and it is just what it sounds like. Stagflation refers to the continuing inflation and stagnant business activity coupled with high unemployment rates. During the 1970s, America experienced an extreme bout of stagflation that resulted in a series of recessions. While many blame the 70s recession on the theory of Keynesian Economics, a closer examination of the causes reveals that stagflation wasn’t entirely the theories fault.

So what exactly did cause the recessions? In 1973, the Organization of Petroleum exporting countries declared an embargo on supporters of Israel-western nations and as a result a recession starts right after. Because there was now a shortage of oil in America, the price of oil more than doubles. Oil is used in almost every product across the economy like plastics, gasoline, etc., so when oil prices shot up, the price of consumer goods shot up too. In reaction to the recession in 1973, the Federal Reserve dropped the interest rate from 11% to 9%. However this worsens the inflation because wages can’t keep up with the increase in products, so purchasing power falls. Realizing that inflation was worsened, the Federal Reserve increases interest rates back up to 14%. This is able to bring down the inflation at a cost of very high interest rates. Therefore, unemployment increases to 9%.

The American economy is able to get out of the recession in 1975, but not without residual effects. The high unemployment rates remain, so to combat it, the Federal Reserve drops the interest rate to 5%, which pulls down unemployment to 6% but inflation starts again. Then in 1979, another shock wave is sent through the economy when oil prices double again as a result of the revolution in Iran. The Federal Reserve attempts to counter the spike by raising interest rates up to 20%. Inflation goes down to 10%, but unemployment jumps up to 8%. The inconsistencies in the economy die down when Reagan takes office, bringing in a new era of conservatism.

After an overview of the stagnant 1970s, it can be seen that the recession was a game of cause and effect. If the Federal Reserve wanted lower inflation than higher unemployment would have ensued. However, the normal Keynesian rules applied even though many blame the recessions on it. The difference was that the baseline of inflation to choose from was much higher than normal because of the oil prices. Oil prices were the main thing to blame and inflation comes down when the oil prices drop or when the economy has adjusted to the high oil prices. In conclusion, less economic dependence on oil could have prevented the catastrophic 1970s.