Objective: To analyse a real-world historical example of stagflation and evaluate the effectiveness of government policies in addressing inflation and unemployment.
Background Information: Stagflation is a rare economic phenomenon characterized by stagnant economic growth, high unemployment, and high inflation. One of the most well-known cases of stagflation occurred in the United States during the 1970s. This period was marked by a series of economic shocks, including the oil crisis, and government policies that were unable to effectively control both inflation and unemployment.
The 1970s oil crisis began in 1973 when the Organization of Arab Petroleum Exporting Countries (OAPEC) proclaimed an oil embargo in response to the United States’ support for Israel during the Yom Kippur War. This embargo led to a severe reduction in oil supply and a sharp increase in oil prices. As oil is a critical input for many industries, the higher oil prices resulted in increased production costs, which subsequently contributed to rising inflation. The oil crisis also disrupted economic growth and led to higher unemployment rates.
The US government attempted to address these issues through a combination of monetary and fiscal policies. The Federal Reserve, under the leadership of Arthur Burns, tried to combat inflation through contractionary monetary policy, which involved increasing interest rates to reduce the money supply. However, this policy contributed to a further slowdown in economic growth and an increase in unemployment.
In addition to monetary policy, the US government implemented fiscal policies to stimulate economic growth and reduce unemployment. This included increasing government spending and cutting taxes in an effort to boost aggregate demand. Unfortunately, these expansionary fiscal policies further exacerbated inflationary pressures and did not significantly reduce unemployment.
In summary, the United States experienced stagflation during the 1970s as a result of the oil crisis and government policies that were unable to effectively control both inflation and unemployment. The combination of contractionary monetary policy and expansionary fiscal policy created a challenging economic environment, with high inflation and unemployment occurring simultaneously.
Table: US Unemployment and Inflation Rates (1970-1980)
Task:
- Analyse the data in the table provided. What trends can you identify in both the unemployment rate and inflation rate during the 1970s? How does this data support the concept of stagflation?
- Explain the contractionary monetary policy implemented by the Federal Reserve under Arthur Burns during the 1970s stagflation. What were the intended effects of this policy on inflation, and what unintended consequences did it have on economic growth and unemployment?
- Describe the expansionary fiscal policy adopted by the US government in response to the stagflation of the 1970s. How did these policies aim to address unemployment, and why did they contribute to inflationary pressures
- Discuss the concept of conflicting economic objectives in the context of the stagflation experienced in the United States during the 1970s. Which objectives were the government trying to achieve, and why was it difficult to address them simultaneously?
- Using an Aggregate Demand/Aggregate Supply (AD/AS) diagram, illustrate the impact of the oil crisis and the government’s policy responses on the US economy during the 1970s. Explain how these events shifted the AD and/or AS curves and led to stagflation.
- Analyse the short-run and long-run Phillips curve in relation to the US stagflation in the 1970s. How do these concepts help explain the simultaneous occurrence of high inflation and unemployment during this period? What policy implications can be derived from the Phillips curve in the context of the 1970s stagflation?