Economic Report of the President

end of 1974 the world price of oil had tripled from about $4 toabout $12 per barrel, thereby adding about $18 billion to our bill forimported oil, or roughly 1.4 percent of gross national product(GNP). Since the price of domestically produced petroleum (which atthat time accounted for about two-thirds of the petroleum used inthe United States) was restrained by controls, the average U.S. priceremained lower than prices throughout the rest of the world. Still,domestic oil prices almost doubled, so that the total increase in consumercosts was almost 3 percent of GNP.During the most recent shock the price of imported oil rose fromabout $15 per barrel at the end of 1978 to $35 at the close of 1980.This added about $50 billion to the cost of the oil we now importinto the United States, or about 2 percent of GNP. Since domesticcrude oil prices were in the process of being decontrolled during thisperiod, the price of domestic oil increased by about $15 per barrel,adding another $60 billion to the oil costs paid by consumers.The forces of inflation during this period were also strengthenedto some extent by the behavior of aggregate demand. There wassome acceleration of wages in 1978 as unemployment fell sharply.And for a time in late 1978 and early 1979, there appeared to be someexcess demand in product markets.Spurred by these developments, inflation surged in 1979 and early1980. As measured by the CPI—which was also heavily influenced bysharp increases in mortgage interest rates—inflation reached annualrates of 15 to 20 percent in the first quarter of 1980. By the spring of1980 the forces that had given rise to this inflationary episode subsided,and the economy entered a brief recession. The measured inflationrate receded from its peak, but the underlying rate appears tohave leveled off in the 9 to 10 percent range, up several notchesfrom the 6 to 7 percent level at which the period had started.THE SOURCES OF INFLATIONThe chief problem with respect to inflation is not the sporadic developmentsthat generate inflationary impulses. Instead, it is theratchet-like nature of the inflationary process which makes it resistantto downward pressures. Chart 3, which shows year-to-year changes inthe consumer price index since 1913, captures the essence of the inflationproblem of the past two decades. The size of the inflationarybursts of recent years has not been out of line with those which occurredearlier in the century, but recent inflation has had an upwardbias and has fluctuated around a rising trend line. An understandingof the "causes" of inflation must therefore encompass not only thevarious factors that give rise to particular inflationary episodes butalso the reasons why inflation has developed a ratchet-like character.37