Stagflation for APUSH
About the Author: Warren Hierl taught Advanced Placement U.S. History for twenty-eight years. He has conducted 250+ AP US History workshops for teachers. He was a member of the committee that wrote the original Advanced Placement Social Studies Vertical Teams Guide and the Advanced Placement U.S. History Teachers Guide. He has been a reader, a table leader, and, for the past eight years, the question leader on the DBQ at the AP U.S. History reading.
In other words- Mr. Hierl grades the essays you will write for the APUSH exam.
Stagflation is a term used to describe high rates of inflation (rising prices) coupled with an economic slowdown (stagnant economy, or low demand) and persistent high rates of unemployment – the economic phenomena definitive of the late 1960s and early 1970s. For policy makers of that time, stagflation was compounded by attempts to correct the economy through either monetary (manipulation of the amount of money in circulation) or fiscal policy (government taxes and spending), which tended to exacerbate the other issue. For average Americans, the increased probability of unemployment, coupled with rising prices was the biggest problem. Finally, the economy drove interest rates to such heights it made home ownership impossible for many.
Stagflation is a term used to describe high rates of inflation (rising prices) coupled with an economic slowdown (stagnant economy, or low demand) and persistent high rates of unemployment – the economic phenomena definitive of the late 1960s and early 1970s.
A Stabilizing Federal Government
The magnitude of the Great Depression led the American public to look to the government for help, as it did when stagflation gripped the economy in the 1970s.
One of the criticisms of the New Deal was the federal government assuming primary responsibility for maintaining a stable economy. This was codified into law in the Employment Act of 1946. The act stated, “Congress hereby declares that it is the continuing policy and responsibility of the federal… government to promote maximum employment, production, and purchasing power.” Accepting the federal government as the primary tool of economic stability contrasted sharply with the traditional laissez-faire attitude of the Gilded Age and the concept of “rugged individualism” popularized in the 1920s. The magnitude of the Great Depression led the American public to look to the government for help, as it did when stagflation gripped the economy in the 1970s.
Keynesian economic theory argues that the federal government should use monetary and fiscal policy to accumulate surpluses in prosperous times and engage in deficit spending during recessions in order to stimulate the economy.
Keynes and the New Deal
During the New Deal, Keynesian economic theory came to the forefront, arguing that the federal government should use monetary and fiscal policy to accumulate surpluses in prosperous times and engage in deficit spending during recessions in order to stimulate the economy. If the economy became inflationary, the government would normally constrict the money supply (through monetary and fiscal policy), lowering demand and causing prices to decline since less money in circulation would mean consumers had less purchasing power. Conversely, if the economy was stagnant and unemployment was high, the government would increase both the money supply and spending, putting more money in consumers’ hands, leading to increased demand.
As a result, both unemployment and inflation rose and attempts to correct one element negatively impacted the other.
The early 1970s witnessed a strange phenomenon that challenged Keynesian economic theory as the economy became stagnant but inflation remained high. As a result, both unemployment and inflation rose and attempts to correct one element negatively impacted the other. As economists debated the causes of stagflation, many settled on rising energy costs as a prime factor. During the Arab-Israeli War in 1973, OPEC (Organization of Petroleum Exporting Countries) instituted an oil embargo against the United States because of its support of Israel. The result was a severe shortage of oil in the United States that caused energy costs to skyrocket. Transportation costs increased significantly, and manufacturers passed the costs on to consumers resulting in expanded inflation and decreased demand. Lines at gas stations became common as motorists lined up in the early morning hours, believing rumors that the stations would have gas when they opened. The gas crisis also led to the development of more fuel-efficient automobiles and a call for U.S. energy independence.
Periodically during the 1970s, the federal government attempted to attack the problems of inflation and unemployment. When the government reduced spending and the money supply, inflation fell but unemployment rose to nearly 9%. When the government pumped money into the economy, unemployment fell but inflation rose to nearly 17%. Interest rates also rose to extremely high levels, discouraging Americans from investing in homes and businesses. Declining construction needs had a ripple effect by decreasing demand for construction materials, leading to increased unemployment.
As the 1970s progressed, Democrats and Republicans disagreed on the best approach to dealing with economic slowdowns, or recessions. Each party adopted an economic philosophy that benefited their political constituents first. Democrats tended to favor a “pump-priming” philosophy of increased spending – putting more money in the hands of consumers to spend the money, create demand, and reduce unemployment. Republicans tended to favor a “trickle-down” theory (more recently termed “supply-side” economics or “Reaganomics). Under this theory, tax cuts to businesses and deregulation encourage investment and business expansion. As business expansion occurs, businesses hire more workers who can then spend money, creating more demand and reducing unemployment. With the resurgence of “new conservatism” under the Reagan administration in the 1980s, the country initially suffered a severe recession but quickly recovered, ushering in a period of economic prosperity. In truth, stagflation posed a problem both political parties and economists seemed incapable of fixing.
The stagflation of the 1970s posed an economic dilemma which stumped politicians and economists.
The stagflation of the 1970s posed an economic dilemma which stumped politicians and economists. A collateral result of stagflation was the ongoing effort to make the United States energy self-sufficient, a movement toward more fuel-efficient cars, and a recognition that the most powerful country in the world had vulnerabilities. Combined with Vietnam’s fall to Communism, the Watergate scandal, the Three-Mile Island nuclear incident, and the exposure of toxic waste dumps, stagflation severely damaged the public’s faith in the federal government. Subsequent fluctuations in the economy indicate that it is a fickle beast not yet tamed, nor likely to be, by politicians or experts.