If you want a contrast, consider the stagflation of the 1970s. Anti-Keynesians are triumphant, and cite it to this day as the ultimate empirical argument; and while Keynesians did rally, they took a lot of the critique (too much, in fact) on board.
And here’s the thing: the era of stagflation, at maximum, lasted from November 1973, when the first oil-shock recession began, to November 1982, when expansionary monetary policy worked exactly the way IS-LM analysis said it should. Long before those 9 years were up, we had proclamations that everything demand-side had been refuted by evidence.
Clever—exactly nine years, Mr. Krugman. But why not peg this to inflation data—after all, if business cycle peak-to-peak interpolation is standard for you, why not use valley-to-valley?
|1969||4.40 %||4.68 %||5.25 %||5.52 %||5.51 %||5.48 %||5.44 %||5.71 %||5.70 %||5.67 %||5.93 %||6.20 %||5.46 %|
|1970||6.18 %||6.15 %||5.82 %||6.06 %||6.04 %||6.01 %||5.98 %||5.41 %||5.66 %||5.63 %||5.60 %||5.57 %||5.84 %|
|1971||5.29 %||5.00 %||4.71 %||4.16 %||4.40 %||4.64 %||4.36 %||4.62 %||4.08 %||3.81 %||3.28 %||3.27 %||4.30 %|
|1972||3.27 %||3.51 %||3.50 %||3.49 %||3.23 %||2.71 %||2.95 %||2.94 %||3.19 %||3.42 %||3.67 %||3.41 %||3.27 %|
|1973||3.65 %||3.87 %||4.59 %||5.06 %||5.53 %||6.00 %||5.73 %||7.38 %||7.36 %||7.80 %||8.25 %||8.71 %||6.16 %|
|1974||9.39 %||10.02 %||10.39 %||10.09 %||10.71 %||10.86 %||11.51 %||10.86 %||11.95 %||12.06 %||12.20 %||12.34 %||11.03 %|
|1975||11.80 %||11.23 %||10.25 %||10.21 %||9.47 %||9.39 %||9.72 %||8.60 %||7.91 %||7.44 %||7.38 %||6.94 %||9.20 %|
|1976||6.72 %||6.29 %||6.07 %||6.05 %||6.20 %||5.97 %||5.35 %||5.71 %||5.49 %||5.46 %||4.88 %||4.86 %||5.75 %|
|1977||5.22 %||5.91 %||6.44 %||6.95 %||6.73 %||6.87 %||6.83 %||6.62 %||6.60 %||6.39 %||6.72 %||6.70 %||6.50 %|
|1978||6.84 %||6.43 %||6.55 %||6.50 %||6.97 %||7.41 %||7.70 %||7.84 %||8.31 %||8.93 %||8.89 %||9.02 %||7.62 %|
|1979||9.28 %||9.86 %||10.09 %||10.49 %||10.85 %||10.89 %||11.26 %||11.82 %||12.18 %||12.07 %||12.61 %||13.29 %||11.22 %|
|1980||13.91 %||14.18 %||14.76 %||14.73 %||14.41 %||14.38 %||13.13 %||12.87 %||12.60 %||12.77 %||12.65 %||12.52 %||13.58 %|
|1981||11.83 %||11.41 %||10.49 %||10.00 %||9.78 %||9.55 %||10.76 %||10.80 %||10.95 %||10.14 %||9.59 %||8.92 %||10.35 %|
|1982||8.39 %||7.62 %||6.78 %||6.51 %||6.68 %||7.06 %||6.44 %||5.85 %||5.04 %||5.14 %||4.59 %||3.83 %||6.16 %|
|1983||3.71 %||3.49 %||3.60 %||3.90 %||3.55 %||2.58 %||2.46 %||2.56 %||2.86 %||2.85 %||3.27 %||3.79 %||3.22 %|
|1984||4.19 %||4.60 %||4.80 %||4.56 %||4.23 %||4.22 %||4.20 %||4.29 %||4.27 %||4.26 %||4.05 %||3.95 %||4.30 %|
|1985||3.53 %||3.52 %||3.70 %||3.69 %||3.77 %||3.76 %||3.55 %||3.35 %||3.14 %||3.23 %||3.51 %||3.80 %||3.55 %|
|1986||3.89 %||3.11 %||2.26 %||1.59 %||1.49 %||1.77 %||1.58 %||1.57 %||1.75 %||1.47 %||1.28 %||1.10 %||1.91 %|
|1987||1.46 %||2.10 %||3.03 %||3.78 %||3.86 %||3.65 %||3.93 %||4.28 %||4.36 %||4.53 %||4.53 %||4.43 %||3.66 %|
The recession of 1970 had wrung the inflationary run-up of 1969 out, so June of 1972? Well, what about unemployment, the Federal Reserve’s other responsibility?
Nixon entered office with 4.40% inflation coupled with 3.4% unemployment. From the BLS records running back to January 1948, Americans would be forgiven for thinking sub-4% unemployment was their birthright, and the late ‘60s were no different (from December 1965 unemployment did not rise above 4.0% until February 1970). Unemployment was nearly 65% higher while inflation was running 38% lower than Nixon’s baseline, so would permitting inflation to rise to 4.40% be all that awful if it would knock off another percentage point or two off the unemployment rate?
Call me quizzical or worse, but given the data, what was Arthur Burns’ huge sin?
Stagflation was a term coined by Paul Samuelson to describe the combination of high inflation and high unemployment. The era of stagflation in America began in 1974 and ended in the early 80s. Why did it happen?
Well, the textbooks basically invoke two factors. One was a series of “adverse supply shocks”, mainly the huge runup in the price of oil. The other was excessively expansionary monetary policy, especially in 1972-3, which allowed expectations of inflation to become entrenched. (Ken Rogoff — a Republican, by the way — attributes that expansion to the desire of Arthur Burns to see Richard Nixon reelected.)
Granted, Krugman doesn’t overtly attack Burns in 2009, but this was less equivocal…
The truth is that whatever you might say about economic policy in the 1970s, it had nothing to do with Keynesian fiscal policy — and did not involve increasing debt. People on the right tend to use “Keynesian” to mean “liberal stuff I don’t like”, but aside from that definition, the 70s tell us nothing about the issues we’re discussing right now. You can argue that monetary policy was too loose, that the Fed was too expansionary in 1972 (when Arthur Burns was trying to reelect Richard Nixon) and that it failed to tighten in the face of oil-shock-driven inflation.
My point, you ask? Well, other than to show that contrary to conventional wisdom the Fed in 1972 was not exercising bad judgement but rather was faithfully executing its duty to the dual mandate, I suggest inflation control was lost and stagflation began when the U.S. inflation rate crossed the 4.40% baseline—in March 1973.
There was hope that the Smithsonian currency alignment in December 1971 would work for some time. The U.S. dollar gained strength in the second half of 1972. Unfortunately, after a heavy speculative attack on the dollar it was suddenly devalued on 12 February 1973 for the second time after World War Two. This time, it was devalued by 10 percent, as the official price of gold was increased from US$38 per oz fine to US$42.22. Soon after the second devaluation, there was another heavy speculative attack on the dollar so much so that foreign exchange markets all over the world had to be closed from 2 March for seventeen days. When the exchange markets were reopened, the major currencies of the world including the US dollar, Deutsch Mark, Japanese Yen, Pound Sterling, French Franc, Dutch Guilder etc. were all floating. The world was now in a floating exchange rate system as a revolt against the IMF fixed exchange rate system.
Bretton Woods chained all commodities to the stipulated price of gold, the $35 an ounce rate set on 05 June 1933, often erroneously referred to as “taking the U.S. off of the gold standard.” It wasn’t anything of the sort—gold sold faithfully at $35 an ounce from 1933 until 18 December 1971, the date of the Smithsonian currency alignment to $38 an ounce. 12 February 1973, as previously quoted, saw gold revalued to $42.22, which collapsed in less than a month. This was why:
The fixed rate of $42.22 was almost exactly 50% of the market price in London. The gold standard had bottled up inflationary pressures just like Second World War, Korean War, and Vietnam-era price controls did. But when international systems of fixed exchange die, as when price controls give way, hang onto your hat.
Oil until the stagflation looked to be locked in at $2.97 a barrel. Bretton absorbed the volatility that is endemic to markets, such as the oil embargo of 1967:
Source for data: BP Statistical Review of World Energy 2010, “Oil: Crude Oil prices 1861-2009”
In the aftermath of IDF stomping its hostile Arab neighbors the Six-Day War, OPEC was able to show its displeasure at the defeat and accomplished…nothing. Bretton took in the shock and spat it back out, enforced by the powerful London Gold Pool from November 1961 until 15 March 1968.
After Bretton ceased almost exactly five years later, so the system’s commodity price regulation:
1973 ushered in a period of very tight supplies in wheat and feed grains worldwide. In 1972, the U.S. had sold over 20 million metric tons of grain to the Soviet Union and dollar devaluations in December 1971 and again in February 1973 sharply stimulated export sales of other agricultural commodities.
The Administration had anticipated some pressure on food prices during the first half of 1973 and had retained mandatory, though looser, controls over the food industry during Phase III. The results, however, were worse than even the most pessimistic predictions. During the first quarter of 1973, consumer food prices shot up at an annual rate of 29.8% while the wholesale price index for farm products rose at an annual rate of 51.9%. Red meat prices alone surged at an annual rate of 90% during the quarter.
In addition, a bizarre incident in the coastal waters off Peru became a symbol of the shortage environment that the world’s agricultural markets suddenly faced. In January 1972, the feared El Nino current appeared off the coast of Peru, pushing aside the fertile waters of the Humboldt Current and destroying the Peruvian anchovy crop. In 1971, Peru had mined ten million tons of this high-protein fishmeal which had become a staple feed ingredient in world livestock markets. By 1973, the anchovies had disappeared and the cost of feeding livestock rose sharply, squeezing producer profits and causing a ripple effect of price hikes along the food chain. In retrospect, as Council members sifted through the wreckage of Phase III, they were to conclude, not entirely tongue-in-cheek, that this obscure “anchovy connection” precipitated the ensuing debacle.
The Council explained that the price increases reflected fundamental market forces: a combination of very strong consumer demand, unprecedented decline in supplies carried over from the previous year and expanded exports due to currency shifts and crop failures abroad. On March 29, 1973, in an abortive attempt to slow the onslaught, the Council slapped a freeze on red meat prices, but this step backfired as ranchers retaliated by withholding supplies and creating meat shortages. Meanwhile, other food prices continued their seemingly inexorable rise.
The Bretton death-shock in the United States was mistaken for a domestic source—the price control regime put into place on 15 August 1971. The controls certainly helped drive down inflation amidst the Vietnam War…
Early in the Council’s deliberations it was decided that the freeze could not simply be lifted after 90 days without some follow-up program and the Council approved a plan to usher in a period of more flexible wage and price controls called Phase II. (Phases of the controls program, like World Wars and Super Bowls, were denominated in Roman numerals.) The Council didn’t want the administrative burden or political responsibility for actually running Phase II, so it established a Price Commission to impose price controls and a Pay Board to limit wage increases. But the Council remained in overall charge.
Phase II rules essentially allowed companies to pass through increased labor and component costs but, by establishing pre-notification requirements and profit margin limitations, they limited company eligibility for price increases. The real action was on the wage side.
The wage freeze and the follow-on Phase II wage standard, limiting wage increases to no more than 5.5%, reduced the inflationary pressure on prices. The labor leaders on the Pay Board were willing to support wage restraint in order to lower the rate of inflation so long as there was discipline on the price side.
Phase II, like the freeze, was a political ten-strike for Richard Nixon and for the U.S. economy. Inflation slowed, economic activity recovered and organized labor grudgingly agreed to moderate wage demands.
…American involvement in the conflict officially ending on 27 January 1973, two weeks into the third phase of the controls. Unfortunately, war in Southeast Asia didn’t end.
The 1970s oil shocks were perpetuated by yet another war, this one in October 1973:
Oct 17, 1973:
OPEC enacts oil embargo
The Arab-dominated Organization of Petroleum Exporting Countries (OPEC) announces a decision to cut oil exports to the United States and other nations that provided military aid to Israel in the Yom Kippur War of October 1973. According to OPEC, exports were to be reduced by 5 percent every month until Israel evacuated the territories occupied in the Arab-Israeli war of 1967. In December, a full oil embargo was imposed against the United States and several other countries, prompting a serious energy crisis in the United States and other nations dependent on foreign oil.
The U.S. Air Force was an active participant in the Yom Kippur war, sending a massive airlift, Operation Nickel Grass:
One of the most critical but least celebrated airlifts in history unfolded over a desperate 32 days in the fall of 1973. An armada of Military Airlift Command aircraft carried thousands of tons of materiel over vast distances into the midst of the most ferocious fighting the Middle East had ever witnessed-the 1973 Arab-Israeli War. MAC airlifters-T-tailed C-141s and C-5As-went in harm’s way, vulnerable to attack from fighters, as they carved a demanding track across the Mediterranean, and to missiles and sabotage, as they were off-loading in Israel.
The fleet consisted of 268 C-141s and 77 C-5As, and Carlton knew that he could sustain a steady flow of three C-141s every two hours and four C-5s every four hours-indefinitely. He also knew that MAC could orchestrate the operation, establishing a rational flow of aircraft matching the cargo to be carried with off-loading equipment at the destination. In his plan, MAC would essentially become a conduit through which materiel would flow in a well-adjusted stream.
But the USAF was even more complicit in the oil embargo. These eight-engine elephants burn far more fuel than C-5s and C-141s, SAC (Strategic Air Command) had more than twice the number MAC employed in Nickel Grass (744 versus 345) and SAC’s bombers struck Southeast Asia for nine years straight:
One of the “Big Belly” B-52Ds releasing its 60,000-pound bomb load of bombs on enemy targets in Vietnam. It could carry up to 84 500-pound bombs or 42 750-pound bombs internally and 24 750-pound bombs externally on racks under the wings. (U.S. Air Force photo)
The United States dropped more than 7.6 million tons of explosives on Cambodia, Laos and the Vietnams, almost four times the tonnage expended during the Second World War. The worst-hit country might surprise you:
The Cambodian bombing campaign had two unintended side effects that ultimately combined to produce the very domino effect that the Vietnam War was supposed to prevent. First, the bombing forced the Vietnamese Communists deeper and deeper into Cambodia, bringing them into greater contact with Khmer Rouge insurgents. Second, the bombs drove ordinary Cambodians into the arms of the Khmer Rouge, a group that seemed initially to have slim prospects of revolutionary success. Pol Pot himself described the Khmer Rouge during that period as “fewer than five thousand poorly armed guerrillas scattered across the Cambodian landscape, uncertain about their strategy, tactics, loyalty, and leaders.”
The Nixon administration knew that the Khmer Rouge was winning over peasants. The CIA’s Directorate of Operations, after investigations south of Phnom Penh, reported in May 1973 that the Communists were “using damage caused by B-52 strikes as the main theme of their propaganda.” But this does not seem to have registered as a primary strategic concern.
This is a time-map of the USAF bombing of Cambodia, an “allied” nation that nevertheless was subjected to 2,756,941 tons of American ordnance, the largest quantities after March 1973:
The last phase of the bombing, from February to August 1973, was designed to stop the Khmer Rouge’s advance on the Cambodian capital, Phnom Penh. The United States, fearing that the first Southeast Asian domino was about to fall, began a massive escalation of the air war — an unprecedented B-52 bombardment that focused on the heavily populated area around Phnom Penh but left few regions of the country untouched. The extent of this bombardment has only now come to light.
The Nixon administration kept the air war secret for so long that debate over its impact came far too late. It wasn’t until 1973 that Congress, angered by the destruction the campaign had caused and the systematic deception that had masked it, legislated a halt to the bombing of Cambodia. By then, the damage was already done. Having grown to more than two hundred thousand troops and militia forces by 1973, the Khmer Rouge captured Phnom Penh two years later. They went on to subject Cambodia to a Maoist agrarian revolution and a genocide in which 1.7 million people perished.
Congress put a stop to these futile, unnecessary raids (the combined 5 million+ tons of bombs that blasted Cambodia and Laos did not shut the Ho Chi Minh Trail and were instrumental in the rise of the Khmer Rouge and Pathet Lao) on 15 August 1973, the second anniversary of Nixon’s price controls. The raids by the SAC behemoths had a direct effect on U.S. fuel consumption:
Source: EIA, table 5.9 “Refinery Capacity and Utilization”, for consumption data: BP Statistical Review of World Energy 2010 “Oil Consumption”.
As the European countries pointed out in the report by GAO in 1973, they were the ones that had to export refined oil (like gasoline) to the US because the US did not have enough refineries to process it autonomously. Now, looking at Table 3 above, one can clearly note how the US oil refineries are processing less of the US oil consumption each year. Even prior to and during the 1967 embargo the US had to import gasoline. Thus, US vulnerability to an oil disruption is clearly connected to its refining capacity. Had the US built more refineries before 1973-74, it would not have had to import gasoline or other refined oil products that were needed in Europe during the crisis as well. This becomes apparent when looking at the gap between the US oil demand and oil refining capacity in 1973. A simple conclusion is that the US could clearly have diminished its vulnerability to an oil disruption, particularly in 1973-74, by building more refineries instead of importing more oil.
I can never disagree with the call to end the U.S. refinery fiasco, but I also want to call attention to the marked drop-off in 1974. Perhaps it is exclusively due to the recession, but one could probably make the argument the refineries should have been built next to Andersen AFB on Guam.