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A Monetary Explanation of the Great Stagflation of the 1970s

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  • Barsky, R.B.
  • Kilian, L.

Abstract

The origins of stagflation and the possibility of its recurrence continue to be an important concern among policymakers and in the popular press. It is common to associate the origins of the Great Stagflation of the 1970s with the two major oil price increases of 1973/74 and 1979/80. This paper argues that oil price increases were not nearly as essential a part of the causal mechanism generating stagflation as is often thought. We provide a model that can explain the bulk of stagflation by monetary expansions and contractions without reference to supply shocks. Monetary fluctuations also help to explain variations in the price of oil (and other commodities) and help to account for the striking coincidence of major oil price increases and worsening stagflation. In contrast, there is no theoretical presumption that oil supply shocks are stagflationary. In particular, we show that oil supply shocks may quite plausibly lower the GDP deflator and that there is little independent evidence that oil supply shocks actually raised the deflator (as opposed to the CPI). The oil supply shock view also fails to explain the dramatic surge in the price of other industrial commodities that preceded the 1973/74 oil price increase and the fact that increases in industrial commodity prices lead oil price increases in the OPEC period.

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Bibliographic Info

Paper provided by Research Seminar in International Economics, University of Michigan in its series Working Papers with number 452.

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Length: 38 pages
Date of creation: 2000
Date of revision:
Handle: RePEc:mie:wpaper:452

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Postal: ANN ARBOR MICHIGAN 48109
Web page: http://www.fordschool.umich.edu/rsie/
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Keywords: STAGFLATION ; COMMODITY PRICES ; OIL MARKET ; MONETARY POLICY;

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References

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  1. Judith A. Chevalier & David S. Scharfstein, 1994. "Capital Market Imperfections and Countercyclical Markups: Theory and Evidence," NBER Working Papers 4614, National Bureau of Economic Research, Inc.
  2. Ben S. Bernanke & Mark Gertler & Mark Watson, 1997. "Systematic Monetary Policy and the Effects of Oil Price Shocks," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 28(1), pages 91-157.
  3. Laurence Ball & N. Gregory Mankiw, 1993. "Relative-price changes as aggregate supply shocks," Working Papers 93-13, Federal Reserve Bank of Philadelphia.
  4. Fuhrer, Jeff & Moore, George, 1995. "Inflation Persistence," The Quarterly Journal of Economics, MIT Press, vol. 110(1), pages 127-59, February.
  5. Christiano, Lawrence J & Eichenbaum, Martin & Evans, Charles, 1996. "The Effects of Monetary Policy Shocks: Evidence from the Flow of Funds," The Review of Economics and Statistics, MIT Press, vol. 78(1), pages 16-34, February.
  6. Ben S. Bernanke & Ilian Mihov, 1995. "Measuring Monetary Policy," NBER Working Papers 5145, National Bureau of Economic Research, Inc.
  7. Andrew Atkeson & Patrick J. Kehoe, 1994. "Models of Energy Use: Putty-Putty versus Putty-Clay," NBER Working Papers 4833, National Bureau of Economic Research, Inc.
  8. Ben S. Bernanke & Mark Gertler, 1995. "Inside the Black Box: The Credit Channel of Monetary Policy Transmission," NBER Working Papers 5146, National Bureau of Economic Research, Inc.
  9. Ben S. Bernanke, 1980. "Irreversibility, Uncertainty, and Cyclical Investment," NBER Working Papers 0502, National Bureau of Economic Research, Inc.
  10. Ben Bernanke, 1990. "The Federal Funds Rate and the Channels of Monetary Transnission," NBER Working Papers 3487, National Bureau of Economic Research, Inc.
  11. Mary G. Finn, 1996. "A theory of the capacity utilization/inflation relationship," Economic Quarterly, Federal Reserve Bank of Richmond, issue Sum, pages 67-86.
  12. Robert J. Gordon, 1986. "Supply Shocks and Monetary Policy Revisited," NBER Working Papers 1301, National Bureau of Economic Research, Inc.
  13. Lawrence J. Christiano & Martin Eichenbaum & Charles Evans, 1994. "The Effects of Monetary Policy Shocks: Some Evidence from the Flow of Funds," NBER Working Papers 4699, National Bureau of Economic Research, Inc.
  14. Boschen, John F & Mills, Leonard O, 1995. "The Relation between Narrative and Money Market Indicators of Monetary Policy," Economic Inquiry, Western Economic Association International, vol. 33(1), pages 24-44, January.
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Cited by:
  1. Eran Yashiv, 2004. "The self selection of migrant workers revisited," LSE Research Online Documents on Economics 19933, London School of Economics and Political Science, LSE Library.
  2. Oladosu, Gbadebo, 2009. "Identifying the oil price-macroeconomy relationship: An empirical mode decomposition analysis of US data," Energy Policy, Elsevier, vol. 37(12), pages 5417-5426, December.

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