The Great Inflation of the 1970s was a policy choice, not bad luck

Who ran up the price of everything in the 1970s? Ask the textbooks of a certain kind and the answer is a sheik. Oil, they say, went up, and prices followed, as if a barrel of crude could reach into every grocery aisle and gas pump and quietly reprice a whole economy by itself. It is a wonderful story, because it has a villain in a faraway country and no one in Washington to blame.

It is also wrong, or at least badly incomplete, and the dates prove it. Inflation was already climbing years before the first oil embargo. Let me define the claim, build the case in order, steelman the other side, and tell you what it means for people who are told every few years that prices are nobody's fault.

The claim

Inflation is a sustained rise in the general level of prices, and the central bank controls the quantity of money that determines it over time. My thesis has three parts. One: the Great Inflation, which ran from about 1965 to 1982, began with decisions about fiscal and monetary policy made in the mid-1960s. Two: it was fed through the 1970s by a Federal Reserve that was under political pressure and persuaded by a faulty theory. Three: the oil shocks of 1973 and 1979 made it worse, but they were an accelerant on a fire already burning.

Let me be careful about what a policy choice means. I am not saying that anyone wanted inflation. I am saying that the officials in charge had the tools to prevent it, had a competing goal that they weighed more heavily, and chose accordingly. That is what a policy choice is.

1965 to 1969: the guns and butter bill

In the early 1960s inflation in the United States ran at low single digits. Then two large commitments arrived almost together. In 1965 Congress passed the Great Society programs, including Medicare and Medicaid, and President Johnson escalated the war in Vietnam. Johnson wanted both, and he declined to ask the country to pay for both through higher taxes immediately. A tax surcharge came only in 1968, after the economy had been running hot for several years.

The mechanism here is not mysterious. When government spending rises faster than the economy's capacity to produce, and when the central bank accommodates it by keeping credit easy, demand outruns supply, and prices rise. William McChesney Martin, who chaired the Federal Reserve through early 1970, had a famous record of resisting pressure, and he did tighten, but he also faced a President who pressed the Fed for lower rates, and the Fed's accommodation, over the whole stretch, was too easy for too long. By the end of the decade inflation had moved well above where it started.

1970 to 1972: Burns, Nixon and an election

In February 1970 Arthur Burns became chairman of the Federal Reserve. Burns was a respected economist, and he had a particular view: that inflation was driven substantially by "cost-push" forces, such as powerful unions and large firms raising prices, and that monetary policy was poorly suited to fight it. If inflation was a product of institutions rather than money, then the right remedy was wage and price controls, not tight credit.

That view was convenient for a President facing an election. Richard Nixon wanted low interest rates and a strong economy going into 1972, and historians, drawing on accounts of the White House recordings released later, describe Nixon pressing Burns for easy credit before the 1972 election. Whether Burns bent because of the pressure or because of his own convictions is a matter that historians still debate. The effect is not in doubt: money and credit expanded in 1971 and 1972, the election year arrived with a boom, and the bill came later.

August 15, 1971: the gold window

On August 15, 1971, Nixon announced a package of measures that is often called the Nixon Shock. He imposed a 90-day freeze on wages and prices. He imposed a surcharge on imports. And he ended the convertibility of the dollar into gold for foreign governments, closing what was called the gold window.

That last step is the one that matters most to this story. Under the Bretton Woods system, the dollar was pegged at $35 an ounce, and foreign governments could redeem dollars for gold. The system constrained how much the United States could inflate, because a country that printed too many dollars would face redemption demands. Closing the gold window removed that constraint. The dollar's last link to gold in the international system was gone, and what held its value from then on was policy. (I compare the monetary regimes that followed, and the conservative disagreement among them, in Gold standard, Friedman's rule or today's Fed, three answers compared.)

Price controls were a political success for a few months and an economic failure over the following years. They suppressed visible prices while the money supply kept growing, and when controls were lifted, in stages over the next few years, prices jumped. Controlled prices, I would remind you, do not stop inflation. They hide it, and then it arrives all at once.

1973 and 1974: the oil shock and the first peak

Now the oil. In October 1973, after the Yom Kippur War, Arab members of OPEC imposed an embargo on oil shipments to the United States and others, and the price of oil roughly quadrupled over the following months. Gasoline lines became the national symbol of the decade. Here is the honest steelman of the other side: this was a real, sharp supply shock, it raised energy prices directly, and it hit an economy that had little room to absorb it.

But look at the sequence. By 1973, before the embargo began, inflation was already high and rising, after the expansion of money and credit in 1971 and 1972 and the end of price controls. The oil shock arrived at a moment when the economy was primed. And the Fed's response to the shock was the lesson: faced with a supply shock that raised prices, it chose to accommodate it, because a hard tightening would have deepened a recession. The result was that a one-time increase in the price of one commodity was converted into a general, ongoing inflation. A supply shock raises the price of oil. It takes monetary accommodation to raise the price of everything else, and keep raising it.

Consumer prices peaked at about 12 percent year over year at the end of 1974. In October of that year President Ford launched a campaign called Whip Inflation Now, and distributed buttons. I want to be fair to the buttons: they were not a policy. They were a slogan with a lapel pin. If a government answers a monetary problem with a pin, it has told you something about how seriously it takes the monetary part.

1975 to 1979: stop and go

The pattern after 1974 was what economists call stop-go. When inflation rose, the Fed tightened a little, unemployment rose, and political pressure mounted, and the Fed eased again. Each cycle ended with inflation higher than the last. The reason is expectations: once households and businesses come to believe that the central bank will not hold the line, they raise their prices and wage demands in anticipation, and the inflation feeds itself.

In 1977 Congress passed an amendment to the Federal Reserve Act, and in 1978 the Humphrey-Hawkins Act, giving the Fed its twin goals of maximum employment and stable prices. I explain that structure in The Fed's dual mandate and the 1977 law that gave it two masters. The relevant point here is that the legal mandate for jobs was clear, and the pressure that the mandate created was a real one.

In 1979 a second oil shock followed the Iranian revolution, and prices of energy again rose sharply. By March 1980 the consumer price index was rising at about 14.8 percent from a year before, the highest reading of the period. That is the second peak, and it is the one that finally forced a change in course. In August 1979 Paul Volcker took office as Chairman of the Federal Reserve. I leave his story for another day, because it is a story of what happens when policy is changed, and my subject here is what happened before.

The theory that failed

The Great Inflation did something to economic theory as well, and that is worth stating directly.

In the 1960s the dominant Keynesian view relied on a relationship called the Phillips curve, which suggested a stable tradeoff: a government could buy lower unemployment by accepting a little more inflation. Paul Samuelson and Robert Solow gave this trade-off its American form in 1960, and policymakers took it as a menu. If you want lower unemployment, order a little inflation.

In 1968 Milton Friedman, in his presidential address to the American Economic Association, argued that the tradeoff could only be temporary. Edmund Phelps made a related argument. Once people expected inflation, the unemployment rate would return to its natural level, and the only lasting result would be higher prices. The 1970s tested the two theories. The result, which the term stagflation, high inflation together with high unemployment, was coined to describe, was exactly what the Phillips curve said could not happen. Prices rose and joblessness rose too. The menu had no such item.

I think the right conclusion is not that Keynes was a fool. It is that a theory used as a license for policy had been taken too far, and that the people who rejected the license were right. Conservatives who warned about inflation in the 1960s had been brushed off as cranks. The decade vindicated them.

The best case for the other side

Let me state it as a defender would. Supply shocks are real. The two oil shocks raised prices directly, and similar shocks hit other countries, many of which also experienced high inflation in the 1970s. The Fed faced genuine uncertainty about how much of the unemployment it saw was cyclical and how much structural, and its estimates of potential output were too optimistic, which led it to ease when it should have tightened. Burns operated under a mandate that gave real weight to employment. The costs of fighting inflation, as the early 1980s showed, were severe, and a central bank that feared them was not irrational.

All of this is true, and I have tried to represent it fairly. But it does not clear the policymakers. The fact that other countries also had inflation shows that the cause was a widespread mistake in monetary thinking, not that the mistake was nobody's. The fact that data were imperfect is an argument for caution, not accommodation. And the oil shocks cannot explain why inflation was rising before 1973 or why it remained high after the price of oil stopped climbing. A one-time rise in the price of a commodity changes relative prices. Only money can change the price level, year after year.

Why it matters now

We come back to this period because every episode of inflation brings out the same defenders. Someone points to a villain: oil, greed, supply chains, a foreign war. Each of these can contribute. But a rise in the price level that persists for years is a monetary and fiscal phenomenon, and the policymakers who control those levers are not bystanders. I apply the same test to a more recent episode in what caused the inflation of 2021 to 2023, weighing the honest evidence, and I count the damage to a family on a fixed paycheck in inflation hurts the poor most, and the arithmetic of a fixed paycheck.

A last historical anchor. The Founders knew what paper money without discipline does; they lived through the Continental dollar, whose collapse gave the country the phrase "not worth a Continental." That is why Article I, Section 10 forbids the states to "emit Bills of Credit" or to make anything but gold and silver coin a tender in payment of debts, and why Article I, Section 8 gives Congress the power "To coin Money, regulate the Value thereof." The 1970s were what happens when the people entrusted with that power forget the reason it was entrusted.

The case in brief

1. The Great Inflation began in the mid-1960s with Great Society and Vietnam spending financed without matching taxes, and with a Fed that accommodated it.
2. Under Arthur Burns, and amid pressure from the Nixon White House, money and credit expanded through the 1971 to 1972 election cycle, and on August 15, 1971, the closing of the gold window removed the last external constraint on the dollar.
3. The 1973 and 1979 oil shocks were real, and the consumer price index peaked at about 12 percent in late 1974 and about 14.8 percent in March 1980, but the shocks fell on an economy already inflating and were converted into general inflation by monetary accommodation.
4. Stagflation broke the Phillips-curve theory that had licensed the policy, and vindicated those who warned that the tradeoff was temporary.
5. Inflation that lasts for years is a policy choice, and the officials who hold the tools own it.

What you can do: look up the consumer price index history in the data published by the Bureau of Labor Statistics, find the dates above, and ask your representative how Congress should prevent a repeat.