Friday, June 24, 2011

Stagflation in the 1970s: A Post Keynesian Analysis

The portmanteau word “stagflation” (stagnation + inflation) refers to the economic problems of the 1970s. We need a clear definition of stagflation, and there are in fact two senses in which it is used:
(1) the simultaneous occurrence of stagnation (low or no growth) and high inflation (the original definition of the term when it was coined by Ian Macleod, in a speech to the British House of Commons, in 1965);

(2) the simultaneous occurrence of rising unemployment rates and rising inflation.
It is sense (2) in which the word is normally used in economics, and it describes high unemployment and high inflation rates (even during recessions) occurring simultaneously. Thus the years from 1975-1977 in the US were not technically stagflation: these were years of an expansion in the business cycle with disinflation (falling inflation rates), rising employment, and rising real output growth.

The most serious periods of stagflation were in 1973–1974/1975 and 1979-1981 when many countries entered recessions and experienced rising unemployment and rising inflation. In most countries, these severe years of surging inflation and unemployment were the result of the first (1973-1974) and second oil shocks (1979-1980), and the double digit inflation rates in many countries (though not all) that provoked the sense of crisis in these years were caused by the high price of energy, a major factor input. But it is also true that from 1968–1970 many countries experienced an unusual rise in wages and prices, with further surges in prices from 1972-1973 before the first oil shock hit their economies. This requires an explanation.

There is no doubt that the era of stagflation was a theoretical and practical problem for neoclassical synthesis Keynesians, with their flawed Hicksian IS-LM models.

But Post Keynesians never had any difficulty explaining stagflation and offering effective cures for it. In particular, Geoff Harcourt explains in the video below (from 20.00 minutes onwards) how Keynes’s General Theory was easily capable of showing that rising unemployment can occur with rising inflation. Harcourt also talks about Lorie Tarshis and his textbook summary of Keynes’s General Theory for American universities in the 1940s, which was attacked by conservatives. Tarshis’s accurate summary of Keynes was rejected for Paul Samuelson’s neoclassical version of Keynesianism (the neoclassical synthesis), and if Tarshis’s book on Keynes had been used instead of Samuelson’s textbook, many of the theoretical problems of neoclassical synthesis Keynesianism would have been avoided.

One of the best analyses of stagflation is by Nicholas Kaldor:
“Inflation and Recession in the World Economy,” Economic Journal 86 (December, 1976): 703–714.
My analysis here is based on Kaldor and other Post Keynesian work.

When we buy many commodities we do not engage in some kind of haggling over price in each individual transaction, or compete with others to bid for a product as in an auction, nor do the prices of many commodities change even though demand has changed. For example, when you go to the supermarket, you do not see daily or weekly fluctuations in the price of milk or bread in accordance with demand for, and sales of, those commodities.

Real world capitalism has developed numerous markets where prices are not set, or explicable, by demand and supply curves. Instead, prices can be (1) administered by business institutions or (2) cooperation between businesses that produce commodities (the familiar concepts of monopoly, oligopoly and cartels). But modern corporations are often institutions that also administer prices, and prices can be stable or unchanged for significant periods of time. Nor do they not respond immediately to demand or sales fluctuations:
“In studies of price determination, business enterprises have stated that variations of their prices within practical limits, given the prices of their competitors, produced virtually no change in their sales and that variations in the market price, especially downward, produced little if any changes in market sales in the short term. Moreover, when the price change is significant enough to result in a significant change in sales, the impact on profits has been negative enough to persuade enterprises not to try the experiment again. Consequently administered prices are maintained for a variety of different outputs over time … The pricing administrators of business enterprises maintain pricing periods of three months to a year in which their administered prices remained unchanged; and then, at the end of the period, they decide on whether to alter them.” (Lee 2003: 288).
What disturbs this?

The price of commodities produced in an economy depends on the costs of factors of production, in particular the wage bill, and then the mark-up over the costs of factor inputs (Musella and Pressman 1999: 1100).

The factors of production are
(1) primary commodities or natural resources, including land, raw materials, water, and energy;
(2) labour, and
(3) capital goods.
Thus inflationary pressures can result from
(1) surges in the prices of primary commodities or energy, especially when the prices of these factor inputs are set on world markets or are influenced by supply shocks;

(2) workers pushing for wage rises, and

(3) business firms increasing their pricing mark-ups.
A vicious circle can result when (a) workers demand wage rises and then (b) firms increase their mark-ups, causing a circle of (a), (b) etc. The distinction must also be made between (1) demand-pull inflation, and (2) cost-push inflation, when the latter has a supply-side cause.

During the most of the Golden Age of Capitalism (1945–1973), primary commodity buffer stocks had ensured price stability. But this policy was changed in the 1960s when the US modified its buffer stock polices:
“… the duration and stability of the post-war economic boom owed a great deal to the policies of the United States and other governments in absorbing and carrying stocks of grain and other basic commodities both for price stabilisation and for strategic purposes. Many people are also convinced that if the United States had shown greater readiness to carry stocks of grain (instead of trying by all means throughout the 1960s to eliminate its huge surpluses by giving away wheat under PL 480 provisions and by reducing output through acreage restriction) the sharp rise of food prices following upon the large grain purchases by the U.S.S.R. [in 1972–1973], which unhinged the stability of the world price level far more than anything else, could have been avoided.” (Kaldor 1976: 228).
From 1968–1971 there were the beginnings of inflationary pressures, in both wages and prices in many industrialised nations. Around 1968–1969, this was reflected in wage rises in Japan, France, Belgium and the Netherlands, and from 1969–1970 in Germany, Italy, Switzerland and the UK, which Kaldor attributes to demands by unions for wage rises (Kaldor 1976: 224). There is of course an eternal struggle in modern capitalism between labour and capital over distribution of income, and sometimes this can get out of control. Post Keynesians recognise the need for some kind of control over wages in modern capitalism, when wage gains become excessive, and the method required is incomes policy of some type. This does not require hostility or opposition to trade unions, however, and Post Keynesian labour theory is, if anything, supportive of organised labour.

But the prelude to stagflation was also marked by a significant explosion in commodity prices that occurred in the second half of 1972. Part of the problem was the failure of the harvest in the old Soviet Union in 1972–1973 and the unexpectedly large purchases on world markets by the Soviet state. That was exacerbated by the uncertainty caused by the break up of the Bretton Woods system,
after Richard Nixon had ended the convertibility of the US dollar to gold on August 15, 1971, an event you can see Nixon announcing in the video below.

The end of Bretton Woods (the post-WWII international monetary system) was momentous: inflation expectations and instability on financial and commodity markets resulted, as well as a rise in commodity speculation as a hedge against inflation. This contributed to the cost-push inflation that was being felt in many countries after 1971. As Kaldor noted, this could have been averted had the United States not dismantled its commodity buffer stock in the 1960s.

The final factor that caused the severe inflation of the 1970s was the first oil shock from October 1973, when various Middle Eastern producers of oil instituted an embargo that lasted until March 1974 (Kaldor 1976: 226). In most countries, the double digit inflation of the 1970s was caused by the oil shocks. This fed into wage-price spirals in a number of countries.

A long-term solution to stagflation proposed by Kaldor was an international system of buffer stocks in major commodities. This could be used to raise commodity prices when they fell to too low a level by buying on the market (which would help incomes in developing nations and other producing nations), and to lower prices by selling into the market when prices were rising too high (Kaldor 1976: 228–229).

In short, Post Keynesian economics can easily understand and deal with stagflation. The wage-price spirals that broke out by the end of the 1960s in some industrialised nations could have been dealt with by incomes policy (national wage arbitration/wage-price controls), and the long-term solution was, and still is, an international system of commodity buffer stocks.


Blaas, W. 1982. “Institutional Analysis of Stagflation,” Journal of Economic Issues 16.4: 955-975.

Cornwall, J. 1990. The Theory of Economic Breakdown: An Institutional-Analytical Approach, Blackwell, Cambridge, MA.

Cornwall, J. 1994. Economic Breakthrough & Recovery: Theory and Policy (rev. edn), M.E. Sharpe, Armonk, N.Y.

Eckstein, A. and D. Heien, 1978. “The 1973 Food Price Inflation,” American Journal of Agricultural Economics 60.2: 186–196.

Galbraith, J. K. 2008. The Predator State: How Conservatives Abandoned the Free Market and Why Liberals Should Too, Free Press, New York.

Hathaway, D. E. 1974. “Food Prices and Inflation,” Brookings Papers on Economic Activity Vol. 1974, No. 1: 63–116.

Kaldor, N. 1976. “Inflation and Recession in the World Economy,” Economic Journal 86 (December): 703–714.

King, J. E. 2002. A History of Post Keynesian Economics since 1936, Edward Elgar Publishing, Cheltenham, UK and Northampton, MA.

Lee, F. S. 2003. “Pricing and Prices,” in J. E. King (ed.), The Elgar Companion to Post Keynesian Economics, E. Elgar Pub., Cheltenham, UK and Northhampton, MA. 285–289.

Musella, M. and S. Pressman. 1999. “Stagflation,” in P. Anthony O’Hara (ed.), Encyclopedia of Political Economy: L–Z, Routledge, London and New York. 1099–1100.


  1. Wow. Nixon's wage and price controls sure fixed things up fine, didn't they? Let's do that again.

    Economics is sure a mystery for those who don't comprehend economic calculation, isn't it?

    1. I guess with commodity buffers, the prices can more effectively be controlled with actual changes in supply. That's not the same as Nixon's price controls, which put a cap on prices without having changes in supply or demand.

  2. Great post. Very interesting. The issue is then why "from 1968–1971 there were the beginnings of inflationary pressures, in both wages and prices in many industrialised nations".

    I think the analysis would gain a lot with the inclusion of productivity and (functional) income distribution. Clearly, these two aspects can´t be taken as part of the "ceteris paribus" variables in this case.

    Regards from Argentina

  3. I find much of the recent discussion on Lorie Tarshis' problems in publishing books to be tinged with a bit of a martyr complex.

    To say that a textbook writer whose books had some problems being published was undergoing ideological persecution is to go beyond hyperbole. The most one gathers is that Bill Buckley had a lone unflattering review of the book back in the day. As if the National Review was a widely read publication before the 1960s, or garnered any interest outside the most elite, educated classes. How could that influence college textbook publication?

    Writing and publishing textbooks is hard work, subject to many constraints that the authors can't help, but this faux-martyr complex can not help their cause. Worse is when some call Tarshis' troubles McCarthyism, which is funny, because Pew polls from the day showed that most neither cared about nor followed McCarthy's "witch-hunts" that hardly amounted to anything other than a few privileged educated people being asked questions in public.

  4. "The most one gathers is that Bill Buckley had a lone unflattering review of the book back in the day"

    (1) It wasn't the only hostile review: in 1947 his book was condemned unfairly in a Economic Council Review of Books review

    (2) there was a campiagn against Tarshis and his textbook, even to the extent of demanding that he be fired:

    "They threatened to stop all donations to the university and mobilized everybody, including even Herbert Hoover, to write to its president and urge the immediate firing ."
    The coming of Keynesianism to America, p. 214.

    (3) The campaign pressured many other universities to not use Lorie Tarshis's book as a textbook for economics, and it worked

  5. Thanks for the information.

    Strangely enough, Subramanian Swamy - a student of Paul Samuelson - claims that even Samuelson was held back in advancement of academic position, because of his relative Keynesianism.

    The Tarshis story makes it seem like Samuelson was among those with the foot inside the establishment, even though Samuelson too had conflicts of doctrine with colleagues. So I guessed that if both a neoclassical and a Keynesian can have conflicts with economics staff during the same era, then it must be more complicated than mere doctrinal difference.

    In light of what you just sourced, perhaps both were pushed down for being Keynesian, one more than another.

  6. LK,

    Do you think that the current policy of maintaining a buffer stock of the unemployed is effectively the 'free market' equivalent fire break of the commodity buffer stocks - possibly when coupled with weak union legislation.

    It appears to serve the same purpose of preventing a spiral occurring, but obviously with much greater human suffering than storing a few barrels of oil somewhere.

  7. "Do you think that the current policy of maintaining a buffer stock of the unemployed is effectively the 'free market' equivalent fire break of the commodity buffer stocks - possibly when coupled with weak union legislation."

    Yes, that's an unusally interesting way of referring to the manner in which neoclassical economics has caused a large stock of unemployed over the past 30 years, usually by appealing to Friedman's natural rate of unemployment.

  8. About the "buffer stock of the unemployed", there is no need to invent new names for things already named... The "reserve army of labour" doesn´t ring a bell?

  9. I do think we should make a distinction between renewable and non-renewable commodities. Agricultural products would fall in the first category while metals and fossil fuels would fall in the second one. Buffer stocks can work well with the first kind in order to level out temporary disturbances. They can also work well with the second kind if faced with only temporary problems (say hurricane Katrina for example).

    But if a non-renewable commodity is at it's global production peak then buffer stocks can only provide help until they are completely depleted. That goes especially for peak oil. Strategic oil reserves (US and IEA members) will help for a few years and maintain a 'comfortable' price range but they can ultimately only be used as a bridge to more energy efficient transport and other demand side contraction measures, not as a permanent solution.

  10. Thanks Lord Keynes, that explains what I could not. I was going with institutional failures of the economic systems at the time to explain the arising stagflation prior to the supply side shocks.
    It also confirms for me my own bias that practically all economics especially today's modern macroeconomics can be explained with buffer stocks.

  11. Hate to bring back an old post, but I wanted to get your opinion on the Phillips Curve.

    I had got to read a piece from Krugman on the NYT talking about how the Phillips Curve hasn't been refuted by the 70s:

    He talks about inflation falling from high levels due to high unemployment, reducing expected inflation, leading to inflation levels staying low as unemployment falls.

    My opinion is that the Phillips Curve is at least to a significant extent true, though I don't have the Post Keynesian explanation.

    What is it?

  12. Hey, old piece I know (doubt you'll even see this) but if you do: I like this article but I do have one question. You claim the removal of buffer stocks is what caused the spike the prices, if I read this correctly. This makes sense, but I've always heard that it was because of price controls. We know the traditional reason for why, shortage and all so need to elaborate.

    Could anyone care to explain?

    Most post-keynesian work I've read has said gov deficits CAN be inflationary, I believe near full employment or when we're nearing the economy's capacity. Couldn't it be argued that gov deficits in the late 60s (tax cuts and Nam spending) were too high for that period? The economy was expanding, unemployment falling and went well below 4% for a while, maybe the fiscal policy was too loose then?

    1. Dismantling of buffer stock policies was one important factor explaining the price shocks in commodities from 1972–1973, yes.

      Yes, budget deficits might have have been a minor factor in the inflation in the late 1960s, but it is a grossly overrated one.

      The reasons I list above were far more important.

    2. OK, perhaps I don't have the dates then...why is it that the textbook story is "Price controls didn't allow prices to adjust, yadda yadda created a shortage, long gas lines etc" This would imply the price controls on oil were still in place, while you say they were removed. I'm just honestly asking.

      I'm just starting to read about the PK school of thought, it's certainly intriguing and more explanatory than any of the mainstream thoughts out there.

  13. Is there ANY way to get one's hands on that Tarshis book? I would love to read it, and if I can get into academia (surely it'd need to one of the few US outposts) I'd love to use it in class, whether it be downloaded and printed, or even try to get it re-published.

    Lofty goals I know, ha, but I'm dedicated to becoming part of PK thought and getting varied views out there!

    1. Yes, you can read it online here:

      The book's full details are:

      Tarshis, Lorie. 1947. The Elements of Economics: An Introduction to the Theory of Price and Employment, Houghton Mifflin Co., Boston.

  14. Lk, you out to take a look at the class on Macroeconomics taught by Peter Navarro. You have the option of Auditing the class and then it's free. I'm listening to the 1st weeks lectures right now and he appears to take the view that Stagflation was Keynes' undoing. How that will play out in Trump's real world policies I couldn't guess, but it's hard to put the label "Keynesian" on a guy who's already frozen Federal Hiring except for the Military. To say nothing of his apparent low opinion of Single Payer.

    At least getting it from the horse's mouth you'll know better whom you're dealing with.