Economic Stagflation in a Historical Context

The term "stagflation"—an economic condition of both continuing inflation and stagnant business activity (i.e. recession), together with an increasing unemployment rate—described the new economic malaise in the 1970's pretty accurately.

Stagflation in the 1970s

Inflation seemed to feed on itself. People began to expect continued increases in the price of goods, so they bought more. This increased demand pushed up prices, leading to demands for higher wages, which pushed prices higher still in a continuing upward spiral. Labor contracts increasingly came to include automatic cost-of-living clauses, and the government began to peg some payments, such as those for Social Security, to the Consumer Price Index, the best-known gauge of inflation.

While these practices helped workers and retirees cope with inflation, they perpetuated inflation. The government's ever-rising need for funds swelled the budget deficit and led to greater government borrowing, which in turn pushed up interest rates and increased costs for businesses and consumers even further. With energy costs and interest rates high, business investment languished and unemployment rose to uncomfortable levels.

President Jimmy Carter's Reaction

In desperation, President Jimmy Carter (1977 to 1981) tried to combat economic weakness and unemployment by increasing government spending, and he established voluntary wage and price guidelines to control inflation. Both were largely unsuccessful. A perhaps more successful but less dramatic attack on inflation involved the "deregulation" of numerous industries, including airlines, trucking, and railroads.

These industries had been tightly regulated, with the government controlling routes and fares. Support for deregulation continued beyond the Carter administration. In the 1980s, the government relaxed controls on bank interest rates and long-distance telephone service, and in the 1990s it moved to ease regulation of local telephone service.

The War Against Inflation

The most important element in the war against inflation was the Federal Reserve Board, which clamped down hard on the money supply beginning in 1979. By refusing to supply all the money an inflation-ravaged economy wanted, the Fed caused interest rates to rise. As a result, consumer spending and business borrowing slowed abruptly. The economy soon fell into a deep recession rather than recovering from all aspects of the stagflation that had been present.

This article is adapted from the book "Outline of the U.S. Economy" by Conte and Karr and has been adapted with permission from the U.S. Department of State.