Stagflation of the 1970s
What is Stagflation of the 1970s?
Stagflation of the 1970s was the combination of high inflation and high unemployment that broke the simple Phillips curve trade-off.
Through the 1970s the United States and other rich economies had rising prices and rising unemployment at the same time, something the standard model of the day said should not happen. The Phillips curve had been read as a menu: accept more inflation and you buy lower unemployment. Stagflation showed that the menu only exists when the inflation is a surprise, because a leftward shift in short-run aggregate supply pushes the price level up and output down together. Two forces were at work, adverse supply shocks from oil and food, and years of inflation that had taught workers and firms to expect more of it, so wage demands built the expected inflation in. The lasting lesson is that the trade-off is short run only, and the long-run Phillips curve is vertical at the natural rate of unemployment.
Stagflation of the 1970s: a worked example
Take an economy sitting on a short-run Phillips curve at 5 percent unemployment and 3 percent inflation. An oil shock raises energy costs, so firms supply less at every price level and short-run aggregate supply shifts left. Unemployment climbs to 8 percent while inflation jumps to 9 percent, so the misery index (inflation plus unemployment) goes from 3 + 5 = 8 to 9 + 8 = 17. No movement along a single downward-sloping curve can produce that, because sliding along the curve trades one variable for the other. The curve itself has shifted up, which is the position policymakers found themselves in.
The mistake students make with stagflation of the 1970s
Students often say stagflation proved the Phillips curve is wrong. It is more precise to say it killed the idea of a permanent trade-off: the short-run curve still exists, but it shifts whenever expected inflation or input costs change, and the long-run curve is vertical. The other frequent error is treating stagflation as a demand problem. Falling aggregate demand lowers inflation and raises unemployment, so it cannot explain both of them rising at once.
Stagflation of the 1970s questions
What caused the stagflation of the 1970s?
Stagflation of the 1970s came mainly from adverse supply shocks, above all sharply higher oil prices, on top of inflation expectations that earlier easy money had already pushed up. Higher input costs shift short-run aggregate supply left, raising prices while cutting output. Because workers expected inflation to continue, wages kept climbing even as jobs disappeared.
Why is stagflation so hard for policymakers to fix?
Stagflation is hard to fix because the two standard tools push the two problems in opposite directions. Stimulating demand lowers unemployment but adds to inflation, while tightening to fight inflation deepens the slump. Only something that lowers production costs or lowers expected inflation improves both at once, and both of those take time.
Is stagflation the same as a recession?
Stagflation is not the same as an ordinary recession; it is a slump that arrives with fast inflation instead of falling inflation. Most recessions come from weak demand, which cools prices as output falls. Stagflation comes from higher supply costs and entrenched expectations, so prices rise even while output stalls.
This is the live Phillips Curve sandbox. Drag the curves, or open the full version.
Related terms
Common comparisons
Get AP Econ exam tips in your inbox
Occasional emails with study tips, new interactive graphs, and exam-season reminders. Free, no spam.
No spam. Unsubscribe anytime. Read our privacy policy.
Keep track of what you have studied
A free EconLearn account adds progress tracking, your quiz history, and achievements. Studying here is free either way, and there is nothing to pay for as a student.
Create a free accountAlready have one? Sign in
Last updated