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A Monetary Explanation of the Great Stagflation of the 1970s

  • Robert Barsky
  • Lutz Kilian

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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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 7547.

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Date of creation: Feb 2000
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Handle: RePEc:nbr:nberwo:7547
Note: ME
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  1. Bernanke, Ben S, 1983. "Irreversibility, Uncertainty, and Cyclical Investment," The Quarterly Journal of Economics, MIT Press, vol. 98(1), pages 85-106, February.
  2. Ben S. Bernanke & Ilian Mihov, 1995. "Measuring Monetary Policy," NBER Working Papers 5145, National Bureau of Economic Research, Inc.
  3. Jeff Fuhrer & George Moore, 1993. "Inflation persistence," Proceedings, Federal Reserve Bank of San Francisco, issue Mar.
  4. Bernanke, Ben S & Blinder, Alan S, 1992. "The Federal Funds Rate and the Channels of Monetary Transmission," American Economic Review, American Economic Association, vol. 82(4), pages 901-21, September.
  5. Robert J. Gordon, 1986. "Supply Shocks and Monetary Policy Revisited," NBER Working Papers 1301, National Bureau of Economic Research, Inc.
  6. 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.
  7. Mary G. Finn, 1996. "A theory of the capacity utilization/inflation relationship," Economic Quarterly, Federal Reserve Bank of Richmond, issue Sum, pages 67-86.
  8. 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.
  9. Patrick J. Kehoe & Andrew Atkeson, 1999. "Models of Energy Use: Putty-Putty versus Putty-Clay," American Economic Review, American Economic Association, vol. 89(4), pages 1028-1043, September.
  10. Laurence Ball & N. Gregory Mankiw, 1993. "Relative-price changes as aggregate supply shocks," Working Papers 93-13, Federal Reserve Bank of Philadelphia.
  11. 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.
  12. 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.
  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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