Causes of Stagflation

Here are some reflections on the causes of stagflation.

“In July 1969, six months into the first Nixon Administration and just twelve days before man took his first steps on the Moon, the Federal Reserve Board raised interest rates. In the midst of all the drama of the times, the raising of interest rates seemed a dull, stodgy, inconsequential event. So, not surprisingly, it was received with calm and, initially at least, understanding. The United States had spent enormous amounts of money on the Cold War, on the Vietnam War, on aid to less developed countries and, above all, on President Johnson‘s welfare society . The resources of even the mighty United States economy were stretched and prices were rising. So the Fed acted ‚to slow the economy down.‘ Its action was, in the conventional wisdom of the time, ‚correct‘. But what happened then?

„One account [in The Indigent Rich, pp.41-2] said that – .. .towards the end of 1969, that is, less than six months after the Fed had acted, policies instituted by the Nixon Administration began to push unemployment up. The intention of these policies was to stop inflation by reducing demand. Demand was to be reduced by reducing personal income, which was assumed to be a function of increasing unemployment. But President Nixon had already arranged in his message to Congress that ‚if unemployment were to rise‘ the programme of unemployment insurance ‚automatically would act to sustain personal income.‘ He had therefore undermined in advance his capacity to attack inflation through increasing unemployment and reducing personal incomes.

„But he was more shackled in his capacity to attack inflation by these means than even this contradiction in his policies demonstrates. For his policies, if they did not reduce incomes as much as the increase in unemployment would have done in an earlier period, they did reduce production. The number of unemployed shot up by more than one million in less than a year. The rate of increase in the gross national product dropped sharply. The President‘s Council of Economic Advisers estimated that the United States economy, in the second quarter of 1970, was operating at about 4 per cent below its potential capacity and that the real rate of growth of GNP in the third quarter was down to 1.4 per cent – or to 2.5 per cent, if the effect of the General Motors strike were excluded. Growth in the fourth quarter was probably nil. The difference between these estimates and the real rate of growth of 5 per cent or more before the advent of recessive policies was substantial; and was borne out by data showing movements in industrial production. From a peak in July 1969, the index of industrial production dropped steadily to a point 7 per cent lower in October 1970. The decline was sharper as unemployment grew (and as the General Motors strike caused further production losses). The index which stood at 173.1 in October 1969, had fallen to 166.1 in September 1970, and 162.3 in October 1970“.

„If it is socially unacceptable to move demand down far enough to balance supply, then the only way of achieving balance in an inflationary situation is to move supply up or, at least, keep it up to meet demand. Our failure to try to do this explains why we have so often had ‚stagflation‘. When insufficiency of supply started to cause inflation, we have applied – and, indeed, we still do apply – monetary and fiscal policies that curtail certain areas of demand, including investment demand, and that curtail production. This reduction of supply while demand necessarily stays up under the pressure of government as well as of private outlays, achieved those twin evils of more unemployment and higher prices.
„When we have reached that point of ultimate frustration, we have then – just as we did in the 1930s – flailed around desperately for remedies roughly within the confines of our existing economic orthodoxies. Wage levels are said to be too high (that was a favourite in the 1930s too); therefore wages should be frozen or cut. Others say we need an incomes policy and price control. Or we should revalue the currency or cut tariffs. Most governments have tried some of these; some have tried them all. None really works…..“

We have learned to live with high rates of unemployment, low rates of real investment, inadequate economic and social welfare, education and health, widespread poverty, inequality, homelessness and all the rest.

„Full employment, especially of labour, achieves a political definition, as distinct from a technical definition, over time. At the end of the Second World War, it was widely considered that a level of 4 per cent of unemployment would constitute a reasonable definition of full employment of labour. Against a background of unemployment during the thirties rising to 20 per cent and even 30 per cent and remaining, for long periods, at or above 10 per cent, it was understandable that 4 per cent should look pretty good. But, as time passed, unemployment began to settle, for long periods and in an increasing number of countries, below 4 per cent and to move towards an almost irreducible level of 1 to 2 per cent. Once people become accustomed to an unemployment level of 1 per cent, then a movement back to a rate of 2 per cent causes what is regarded as widespread distress and 3 per cent or 4 per cent comes to be regarded, in many countries, as a national disaster.“

What is certain, whether thirty years ago or now, is that unemployment causes, to put it at its lowest, a dreadful waste of valuable human resources. In recent years, in the developed world, we have become used to unemployment rates of over 5% and often over 10%. In many of the poorer countries, the chronic rate is 20, 30, 50% or even more. Underemployment is as much a curse as unemployment. Wage rates, even for the fully employed, often do not constitute an adequate living income.

Unemployment and underemployment of those who want to work reduce the potential of the society in which they occur, limit human aspirations and frustrate the „impossible“ dreams of both individuals and societies.

Starting with the Nixon policies of 1969 – which were adopted by other governments and were approved and continue to be approved by mainstreamer economists right up to the present day – we moved away from full employment.”

In understanding stagflation, one sees the paradigm shift, which has enabled the conservative movement to rise up in power ever since the 1970s. Ever since then, the Keynesian, Fordist-Taylorist model had been discredited, government intervention can not get it right, and to add to the insult of working people, who have been battered since this unraveling and paradigm shift in U.S. economic policy, international competition was reducing the American pie, so the argument of American big business goes. It is all a hoax.  Relatively speaking, they had a point in that other nations were picking up to the United States, because after World War II it was the only nation that remained prosperous, but Europe was soon recovering from the devastating war (with U.S. support), and China and India were rising in the 1980s. (The economist Hans Rosling describes it in his fascinating life expectancy and economic development graph throughout history But if U.S. big business were right in claiming that the American pie was shrinking their corporate profits would have decreased. Has it decreased? No, corporate profits went soaring, executive bonuses sky-rocketed, but millions of workers were laid off, so that more jobs can be shipped overseas. The disaffected American worker is made to accept a deteriorating standard of living and not oppose the “inevitable” trend toward globalization, which is a guise word for more concentration of wealth to the top. This time the worker base is going global, and the corporations in the west and the east can increase exploitation among all workers, while feeding them with the nonsense that the pie is shrinking, just as the rationale for budget cuts, which dismantles the New Deal and the Great Society. And this has not only to do with numbers. Unemployment, lack of health insurance, decreasing standard of public schools, growing unaffordability of a college education, evaporating retirement funds, home foreclosures, protests, demonstrations, right-wing business, right-wing media and right-wing politics are all part of the same problem, feeding and reinforcing on itself. All of this is undergirded by the disappearance of the labor unions, the omnipotence of big business and the complicity of the government and the media. Under no circumstances can unemployment be made justifiable.

The playing up of fears against hyperinflation or stagflation are overly exaggerated, and as the article points out, could be tackled by increasing supply instead of reducing demand. Ironically, it is the adherence to those free market values over the past 30 years, which has the greatest potential to cause hyperinflation and stagflation. In order to restore the economy, the Fed is desperately trying to print more money for those big financial institutions in the hopes that they extend more loans to businesses and individuals. Instead they use the money to buy treasury bonds at higher interest rate, which means that the taxpayer (who is already battered, except the rich) has to pay off the bill. This is an invitation for a further depression in demand, which makes the money-hoarding corporations ever more willing to expand overseas and hoard more cash instead of creating jobs here at home. Welcome to the capitalist mode of logic! Also I am doubting that the concentration of wealth at the top is capitalism. This to me looks like plain theft. The inability of the people to make decent wages to buy those products means the only way for big corporations and banks to make profit is to commit theft on the American people, preferably via the government and the tax system. It doesn’t take long and the pyramid will crumble, but it requires conscious effort by the people.

Quoted from

Cumes, James. “Inflation, Stagflation and Unemployment.” Studien Von Zeitfragen. Web. 01 May 2011.
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One Response to Causes of Stagflation

  1. Pingback: The Return of Stagflation? | Logarchism

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