Stagflation: How We Got Into It - How To Get Out

Harold van B. Cleveland and Thomas F. Huertas

From Foreign Affairs, Fall 1979

Article preview: first 500 of 7,244 words total.

Summary:  Ten years ago a combination of rising inflation and incipient recession signaled the end of the Soaring Sixties. Yet few contemporary observers perceived that the end of the long postwar expansion was at hand, or that the coming decade would perhaps one day be labeled the Sagging Seventies.

Harold van B. Cleveland and Thomas F. Huertas are Vice-Presidents in the Economics Department of Citibank. This article reflects the personal opinions of the authors and not those of Citibank N.A.

Ten years ago a combination of rising inflation and incipient recession signaled the end of the Soaring Sixties. Yet few contemporary observers perceived that the end of the long postwar expansion was at hand, or that the coming decade would perhaps one day be labeled the Sagging Seventies.

The contrast between the two periods is indeed marked. During the great postwar boom, from 1958 to 1973, the average annual rate of growth of the gross national product, adjusted for inflation, exceeded five percent in the seven largest industrial countries, Britain, Canada, France, Germany, Italy, Japan and the United States. This growth rate was high not only compared to the period since 1973, but also historically. Yet from 1973 to 1979, the average annual growth of the same seven economies fell to only two and one-half percent. And, as growth collapsed, inflation surged. Prices in the same countries, which had advanced at only three and one-half percent in the earlier period, speeded up to eight percent from 1973 to 1979.

Persistent, high inflation and low, halting growth, along with high unemployment, unstable exchange rates and sluggish investment are the symptoms of an economic disease that economists call stagflation, a rare malady that had not previously afflicted the industrial West. Because its onset dates from the first show of muscle by the Organization of Petroleum Exporting Countries (OPEC) in the winter of 1973-74, many observers have been led to lay the problem at OPEC's door.

The conclusion is plausible, especially right now when OPEC's latest round of oil-price hikes promises to aggravate the current recession in the United States, much as the first oil shock deepened and prolonged the worldwide recession of 1974-75. But a closer look suggests a different conclusion. The most important causes of stagflation in advanced industrial countries are not external. They are rooted in economic policies followed by these countries since the early 1960s and, more fundamentally, in the social values and political priorities those policies express. In short, our worst economic wounds are self-inflicted. Their healing therefore depends on our own efforts.

To understand stagflation, one must understand the postwar boom that preceded it. Broadly speaking, from the early 1950s until the early 1960s, a favorable conjuncture of factors on the supply side of the industrial economies made possible a period of unusually rapid growth without much inflation. Thereafter these unusual sources of growth faded, but growth of GNP was strong into the early 1970s, mainly because the United States employed highly stimulative monetary and fiscal policies in order to finance simultaneously domestic social programs and the Vietnam War. Although these policies brought about an unusually rapid rise in output and employment throughout the industrial world, they also led to accelerating inflation, a breakdown of the international monetary system and erosion of public confidence in money and its management. The end result was stagflation. The public's loss of confidence in the management of money is, we believe, the core of the stagflation malady.

Trust in money, ...

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