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Supply vs. Demand Approaches to the Problem of Stagflation

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  • Michael Bruno
  • Jeffrey Sachs

Abstract

We develop a model of aggregate supply and demand in the open economy to explain the important characteristics of international macroeconomic adjustment in the 1970s. Traditional demand-oriented models cannot account for the worldwide phenomenon of rising inflation and unemployment in the mid-70s, or for the failure of most industrialized economies to recover from the deep recession of 1974-75. When aggregate supply is carefully treated, it is found that much of the inflation and sluggish output performance may be attributed to the jump in the real costs of intermediate inputs and the failure of real wages to adjust downward after the input price shock. A simulation model shows that fuel inputs are sufficiently important in production that a large part of the worldwide recession may be attributed to the change in the relative price of oil, since 1973. In an empirical section, it is suggested that countries differ in their response to supply shocks and macro-policies because of differences in key structural relationships, particularly in wage determination.

Suggested Citation

  • Michael Bruno & Jeffrey Sachs, 1979. "Supply vs. Demand Approaches to the Problem of Stagflation," NBER Working Papers 0382, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:0382
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    File URL: http://www.nber.org/papers/w0382.pdf
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    1. Martin Feldstein & Lawrence Summers, 1977. "Is the Rate of Profit Falling?," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 8(1), pages 211-228.
    2. Bruno, Michael, 1978. "Exchange Rates, Import Costs, and Wage-Price Dynamics," Journal of Political Economy, University of Chicago Press, vol. 86(3), pages 379-403, June.
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    Cited by:

    1. Richard B. Freeman & John T. Dunlop & R. F. Schubert, 1980. "The Evolution of the American Labor Market, 1948-80," NBER Chapters,in: The American Economy in Transition, pages 349-414 National Bureau of Economic Research, Inc.
    2. William H. Branson & Julio J. Rotemberg, 1991. "International Adjustment with Wage Rigidity," NBER Chapters,in: International Volatility and Economic Growth: The First Ten Years of The International Seminar on Macroeconomics, pages 13-44 National Bureau of Economic Research, Inc.
    3. Bas B. Bakker, 2015. "Employment and the Great Recession; The Role of Real Wages," IMF Working Papers 15/229, International Monetary Fund.

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