# Understanding Stagflation: Lessons from the 1970s Economic Crisis
Written on
Chapter 1: The Dread of Stagflation
To grasp the concept of stagflation, it’s essential to examine the economic landscape of the 1970s. This period was marked by a unique blend of stagnant economic growth and high inflation, creating a challenging environment that many have never faced since.
It's important to note that I don't foresee a recession in the immediate future. This perspective stems not from an expectation that the Federal Reserve will execute a flawless economic strategy, but rather from the belief that they lack the resolve to implement the necessary interest rate hikes to effectively curb inflation while simultaneously avoiding a significant recession. The stock market is likely to react negatively before such measures could be fully realized, prompting the Fed to halt its tightening approach.
Section 1.1: The Threat of Persistent Inflation
Consider the scenario where the Fed does inadvertently trigger a recession, even as inflation remains stubbornly high—prices are currently on track to double every nine years. If inflation becomes ingrained in our economic psyche, it could initiate a wage-price spiral. Individuals, anticipating continued high inflation, may demand larger salary increases, which would compel companies to raise prices further, perpetuating the cycle of inflation and wage demands. This situation presents a frightening economic reality that many have never encountered—stagflation.
Subsection 1.1.1: Historical Context of the 1970s
The 1970s serve as a poignant example of this phenomenon. Prior to Paul Volcker's aggressive interest rate hikes, the economy was plagued by simultaneous recessions and rampant inflation. Typically, recessions are associated with fears of deflation; however, during this period, we witnessed rising costs for essentials like rent, energy, and food, even as unemployment climbed. The Fed found itself unable to lower real interest rates effectively to stimulate growth, as inflation continued to rise.
Section 1.2: Deflation vs. Stagflation
Deflation can be detrimental, but it’s arguably simpler to manage than stagflation. The remedy for deflation often involves lowering interest rates and encouraging credit growth, which can invigorate spending and stimulate the economy. In contrast, combating stagflation is a precarious balancing act. Increasing rates to combat inflation may exacerbate unemployment, while lowering rates to address rising joblessness could ignite hyperinflation. It’s a dilemma without a clear solution.
Chapter 2: Recession and Unemployment Trends
The economic turmoil of the 1970s is vividly illustrated by the frequency of recessions over just 12 years. Since the 2008 financial crisis, we haven’t truly experienced a recession, aside from a brief downturn during the COVID-19 pandemic. In contrast, the 1970s and early 80s faced four distinct recessions. Notably, during the first three of these downturns, inflation surged, necessitating sustained high interest rates to combat it.
The correlation between rising unemployment and economic instability is stark. The unemployment rate struggled to recover in the 1970s due to the lack of economic stimulus and the close intervals between recessions. It wasn't until the 1980s, when inflation was finally brought under control and interest rates began to decrease, that the job market started to improve.
The spectrum of potential economic outcomes today is as broad as it has been since 2008. It’s crucial that we prepare ourselves for various possibilities, whether they manifest positively or negatively.
If you found value in this article and appreciate my writing, please consider supporting my work by joining Medium through my referral link. Thank you!