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How the Great Inflation of the 1970s Happened

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Inflation
Drivers queue for fuel at a US petrol station, during the worldwide fuel shortages caused by the oil embargo imposed by the Organization of Arab Petroleum Exporting Countries (OAPEC), circa 1974.

Pictorial Parade / Getty Images

It's 1974. The inflation rate hit double digits in February of 1974 and would stay in double digits until May 1975.

Not much was looking any better. The stock market lost about a third of its value from the beginning of the decade to late 1974. In that same year, the unemployment rate was above 7%.

The easy money policies of the Federal Reserve were meant to generate full employment by the early 1970s. Instead, they caused inflation to soar.

Under new leadership, the central bank reversed its policies, raising interest rates steadily. Mortgage rates would climb to double digits by 1978 and kept climbing before peaking at 18.45% in 1981.

Key Takeaways

  • Rapid inflation occurs when the prices of goods and services suddenly rise, eroding the purchasing power of consumers.
  • The 1970s saw some of the highest rates of inflation in modern U.S. history.
  • In turn, mortgage interest rates rose to nearly 20%.
  • Fed policy, the abandonment of the gold standard, Keynesian economic policies, and market psychology all contributed to high inflation.
  • Lower inflation would return only after a tough period of tight money and recession.

The Great Inflation of the 1970s

Overall, the macroeconomic event known as the Great Inflation stretched from 1965 to 1982. That means the economic disruption started during the era of President Lyndon B. Johnson and continued through the presidencies of Richard Nixon, Gerald Ford, and Jimmy Carter.

The most painful period began in late 1972 and continued into the early 1980s.

In his book, "Stocks for the Long Run: A Guide for Long-Term Growth", Wharton professor Jeremy Siegel called this time "the greatest failure of American macroeconomic policy in the postwar period."

Spreading the Blame

The Great Inflation was variously blamed on oil price manipulation by OPEC, currency speculators, greedy businessmen, and avaricious union leaders.

However, monetary policies that financed massive federal budget deficits deserve much of the blame. As economist Milton Friedman wrote in his book, "Money Mischief: Episodes in Monetary History". inflation is always "a monetary phenomenon."

The Great Inflation and the recession that followed ruined many businesses and hurt countless individuals. Interestingly, John Connally, the Nixon-installed Treasury Secretary with no formal economics training, later declared personal bankruptcy.

Yet these unusually bad economic times were preceded by a period in which the economy boomed or appeared to boom. Many Americans were awed by the temporarily low unemployment and strong growth numbers of 1972.

In 1972, they overwhelmingly re-elected a Republican president, Richard Nixon, and a Congress controlled by Democrats.

Causes of the Great Inflation

Upon his inauguration in 1969, Nixon inherited a recession from Lyndon Johnson, who had spent generously on the social programs of the Great Society and the Vietnam War.

Despite some protests, Congress went along with Nixon and continued to fund the war and increase social welfare spending. In 1972, for example, Congress and Nixon agreed to a big expansion of Social Security—just in time for the elections.

Nixon's Changing Viewpoint

Nixon came to office as a supposed fiscal conservative. However, he ran up the budget deficit and eventually declared that he was a Keynesian. John Maynard Keynes was an influential economist of the 1930s and 1940s who advocated countercyclical policies in hard times, running deficits in recessions to pump money into the economy.

Before Keynes, governments had met recessionary times with balanced budgets and waited for businesses to adjust or liquidate. The object was to allow market forces to bring about a recovery without government intervention.

Nixon's other economic about-face occurred when he imposed wage and price controls in 1971. They were a short-term success politically. Later, they would fuel the fires of double-digit inflation because, once they were removed, businesses boosted prices to recover lost ground.

Nixon's deficits also made dollar-holders abroad nervous. There was a run on the dollar, which many foreigners and Americans thought was overvalued. Soon they were proved right.

In 1971, Nixon broke the last link to the gold standard, turning the American dollar into a fiat currency. The dollar was devalued and millions of foreigners holding dollars, including oil barons in the Middle East with tens of millions of petrodollars, saw their wealth fall. 

Election Year Politics

Still, President Nixon's primary concern was not the U.S. dollar, or deficits, or even inflation. He feared another recession.

He and others who were running for re-election wanted the economy to boom. The way to do that, Nixon reasoned, was to pressure the Fed to lower interest rates.

Nixon fired Fed chair William McChesney Martin and installed presidential counselor Arthur Burns as his successor in early 1970.

Nixon wanted cheap money. That meant low interest rates to promote growth in the short term and make the economy seem strong as voters went to cast their ballots.

Note

Richard Nixon was forced to resign from the presidency in August 1974, as a result of the infamous Watergate scandal. His successor, then-Vice President Gerald Ford, would lose the next presidential election to Democrat Jimmy Carter.

The Politics of Cheap Money

In public and private, Nixon put the pressure on Burns. William Greider, in his book, "Secrets of the Temple: How the Federal Reserve Runs The Country", Nixon is quoted as saying, "We'll take inflation if necessary, but we can't take unemployment."

The nation got an abundance of both.

The key money creation number, M1, calculates the total cash in circulation at a given time. It grew from $228 billion to $249 billion between December 1971 and December 1972, according to Federal Reserve Board numbers. As a matter of comparison, in Fed chair Martin's last year, M1 grew from $198 billion to $206 billion. M2, which measures retail savings and small deposits, grew even more by the end of 1972, from $710 billion to $802 billion.

Adding to the money supply worked in the short term. Nixon carried 49 out of 50 states in the election. Democrats easily held Congress. Inflation was in the low single digits.

However, the country paid the price in higher inflation once the election year festivities ended.

In the winters of 1972 and 1973, Burns began to worry about inflation. In 1973, inflation more than doubled to 8.8%. Later in the decade, it would go to 12%. By 1980, inflation was at 14%.

Was the United States about to become another Weimar Republic experiencing the brutal effects of crippling inflation?

The Great Inflation period would finally come to an end once later Fed chair Paul Volcker pursued a bold but painful contractionary money policy to control it.

What Is Inflation?

Prices for individual products fluctuate up and down constantly, but a continuing increase in the prices of a broad group of essential goods and services results in inflation.

When inflation occurs, consumers get less for every dollar they spend. Effectively, their income has decreased.

What Was the Great Inflation of the 1970s?

The period in the 1970s and extending into the early 1980s was a time of relentless inflation. The inflation rate, as measured by the Consumer Price Index, rose to as high as 14% in 1980.

Federal Reserve policy that promoted a large increase in the money supply is considered the main reason for the Great Inflation.

How Did the Great Inflation Affect Americans?

The steady and lasting rise in prices seen during the Great Inflation created a time of tremendous financial pressure for most Americans.

People found it difficult make ends meet. They worried about depleting their savings to cover the gap between their income and their expenses. They had to make unpleasant choices about which items to buy.

The deeply unsettling effect of inflation eroded their standard of living and their confidence in the country's leadership.

The Bottom Line

It would take another Fed chair and a brutal policy of tight money—including the acceptance of a recession—before inflation would return to low single digits.

In the meantime, workers would endure jobless numbers that exceeded 10%. Millions of Americans were suffering from day to day by the late 1970s and early 1980s.

Few remember Fed chair Burns, who in his memoirs, "Reflections of an Economic Policy Maker (1969-1978)", blames others for the Great Inflation without mentioning the disastrous monetary expansion. Nixon didn't even mention this central bank episode in his memoirs. Many who remember this terrible era blame it on the Arab oil producers for manipulating the global oil supply.

Still, The Wall Street Journal, when reviewing this period in January 1986 wrote, "OPEC got all the credit for what the U.S. had mainly done to itself."

Article Sources
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  19. Federal Reserve History. "Volcker's Announcement of Anti-Inflation Measures."

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