[Joseph_E._Stiglitz,_Carl_E._Walsh]_Economics(Bookos.org) (1)

the 1970s saw unemployment and inflation both rise. During the first half of the
1970s, unemployment averaged 5.4 percent, essentially the same level as before the
Kennedy tax cut; yet as unemployment rose from the low levels of the late 1960s,
inflation remained high. Chapter 31 will explain why the unemployment–inflation
trade-off seemed to disappear in the 1970s. Policymakers found themselves
confronting very different economic situations from those in the previous decade.
One new situation was caused by a disruption of oil supplies and a rise in oil
prices. In the 1970s, the members of the Organization of Petroleum Exporting
Countries (OPEC) were able to raise the world price of oil significantly. This action
both contributed to the general increase in prices in oil-importing countries and
changed the behavior of households and firms. Higher gas prices created incentives
for consumers to economize on gas, and households started buying smaller, more
fuel-efficient automobiles. In the United States, many of these cars were produced
in other countries, particularly Japan, because U.S. automakers were slow to alter
the products they made to respond to changes in consumer demand. Firms also
needed to adjust their production techniques to conserve energy and adopt more
energy-efficient equipment, as well as to produce the more energy-efficient goods
that consumers now desired.
During the 1970s, unemployment averaged more than 6 percent, while inflation
averaged more than 7 percent per year. This experience with high inflation and high
unemployment was called stagflation. Numerous attempts to control inflation were
made without success. In 1971, President Nixon imposed price and wage controls.
These temporarily reduced inflation but failed to address the underlying causes,
described in Chapter 31 . As soon as the controls were lifted, inflation reappeared.
THE CONQUEST OF INFLATION
At the end of the 1970s, most industrial economies continued to suffer unacceptably
high rates of inflation. The last big oil price increase of the decade occurred in
1979 and helped push inflation rates to new highs in many countries.
The turning point in the battle against inflation actually occurred in October
1979, when Paul Volker, President Jimmy Carter’s newly appointed chairman of the
Federal Reserve System, shifted economic policy. Under Volker, the Federal Reserve
adopted policies designed to reduce inflation. Chapter 32 will describe how
the Federal Reserve is able to affect the economy. As part of its policy changes, the
Federal Reserve began to focus more on controlling the money supply. Interest rates
rose to record highs, but Volker’s policies succeeded in getting inflation down.
Reducing inflation wasn’t costless, however. By 1982, unemployment reached 10 percent,
the highest level in the post–World War II era. President Ronald Reagan’s ratings
in the polls sank to low levels. Many Democrats thought Reagan was sure to be
defeated when new elections were held in 1984.
But during 1984 the economy expanded. Chapter 24 will explain why increases
in unemployment tend to be temporary, with the economy eventually returning to
full employment. By the time of the presidential election, the unemployment rate had
fallen to 7.2 percent, yet inflation remained relatively low. With the macroeconomy
improving, Reagan coasted to a landslide reelection victory.
478 ∂ CHAPTER 21 MACROECONOMICS AND THE ECONOMIC PERSPECTIVE