Indian Economy · Economy0020
Stagflation and the 1970s Oil Crises
Stagflation is high inflation alongside weak growth and high unemployment. Prices climb, yet the economy struggles to make goods and jobs. This differs from ordinary inflation during a fast boom. It also differs from a recession with falling prices.
The 1970s oil shocks made this puzzle clear. Oil became costly. Many firms faced higher bills. At the same time, many households and firms cut other spending.
Two different oil shocks
1973–74: Arab oil embargo
After the October 1973 war, Arab oil exporters imposed an embargo on some countries. Oil supply was also cut. Oil prices jumped. Petrol lines became a visible sign of the shock.
1978–80: Iran disruption
Iran’s revolution disrupted oil output from late 1978. Fear of more shortages raised demand for stored oil. Prices rose sharply in 1979. This was not the same embargo as 1973.
Both shocks hit a world that already had other economic problems. Food prices, demand, wages, and earlier policy choices also mattered. Oil alone does not explain every year of inflation.
QUICK CHECK 1 OF 6 · TRUE OR FALSE
Stagflation means prices fall while growth is weak and jobs are scarce.
High inflation, weak output, and high unemployment can occur together.
How can high prices and weak output occur together?
Oil fuels transport and many factories. If oil costs more, making and moving goods costs more. Firms may raise prices. They may also make less or delay hiring.
Buyers compete for less oil.
Fuel and transport bills rise.
Some raise prices or cut output.
Inflation and job loss can coexist.
Economists call this a negative supply shock. The economy can produce less at the old cost. Prices rise even without an extra wave of customer demand.
One shop gives a simple example. Delivery fuel becomes dearer. The shop raises prices to cover costs. Customers buy fewer other goods. The owner then cuts staff hours.
QUICK CHECK 2 OF 6 · TRUE OR FALSE
The 1973–74 oil shock was only a surge in consumer demand.
The embargo and supply limits pushed oil prices up. Other causes also shaped inflation.
Why did the Phillips Curve look wrong?
The Phillips Curve describes a short-run link between inflation and unemployment. A simple version suggests lower joblessness may come with higher inflation. Some planners once treated this as a stable trade-off.
In the 1970s, oil costs rose and output weakened. Inflation and unemployment rose together. The old simple picture could not explain this well.
Move along one curve: With expectations and supply costs held steady, lower unemployment may come with higher inflation.
Shift the curve: Costlier oil or higher expected inflation can lift inflation at the same unemployment. Compare A with B. From A to C, both inflation and unemployment rise.
Long run: A vertical Phillips Curve is a model of unemployment returning toward a natural-rate estimate. It does not promise a fixed rate or a permanent trade-off.
This is a simplified teaching diagram. The short-run link changes across time and countries. It is not a mechanical law or a forecast.
Sources: Federal Reserve on short- and long-run curves; San Francisco Fed on 1970s shifts.
Expectations also changed. Workers expected more price rises and asked for higher pay. Firms expected higher wage and fuel bills. They set prices with those costs in mind. This can keep inflation going after the first shock.
The non-accelerating inflation rate of unemployment (NAIRU) is an estimate of joblessness linked to stable inflation. It is not a fixed number written in law. Supply shocks and changing expectations make it hard to measure.
QUICK CHECK 3 OF 6 · TRUE OR FALSE
A simple Phillips Curve can fail when inflation expectations and supply costs change.
The 1970s showed that inflation and unemployment can rise together.
The policy dilemma
Raise interest rates?
This may cool demand and inflation. It can also slow loans, output, and hiring in the short run.
Spend more or cut rates?
This may support jobs for a while. If demand rises too much, inflation may last longer.
There was no painless switch for a world oil shortage. Governments could help households facing high energy bills. They also had to avoid feeding a wider price spiral. Saving energy and building other supplies took time.
In October 1979, United States Federal Reserve chair Paul Volcker began strong anti-inflation measures. Interest rates rose sharply. United States inflation fell by late 1982. The cost included a severe recession and job losses. This shows why timing and expectations matter.
Worked example. Volcker pushed the Fed’s key interest rate above 19% at its peak, far higher than normal. Borrowing for a house or a car became very expensive almost overnight. Unemployment rose past 10% by 1982. But US inflation, which had run near 14% in 1980, fell to around 3% by 1983. The trade-off was real: a painful recession bought a lasting drop in inflation.
The 1970s also taught a wider lesson. A central bank needs to keep inflation expectations stable. A supply shock may begin the problem, but policy can make it last.
Exam points and indicators
- Look at three signs: inflation, real output growth, and unemployment. One price rise is not enough.
- Stagflation can start with a supply shock. It need not start with too much spending.
- The 1973 embargo and the 1979 Iran shock were different events.
- The Phillips Curve is about inflation and unemployment. It is not a measure of income gaps.
- Raising rates can lower demand. It cannot directly create more oil.
See CDS II 2021, Q69 for the exam wording.
QUICK CHECK 4 OF 6 · TRUE OR FALSE
The Phillips Curve mainly measures income inequality.
It describes a relationship between inflation and unemployment, not income distribution.
India and later oil shocks
India buys much of its oil from abroad. A higher world price can raise its import bill and fuel costs. It may strain the trade balance and the rupee. How much reaches household prices depends on taxes, subsidies, and other choices.
The Reserve Bank of India notes that the 1973 and 1979 oil shocks added to inflation. It also names drought and money growth among the other forces at work.
Later crises can also bring costly energy and slower growth. Yet a modern oil shock is not automatically a repeat of the 1970s. Energy use, wage setting, central banks, and other conditions differ. Check the data before calling an episode stagflation.
Primary sources
- Federal Reserve History: 1973–74 oil shock.
- Federal Reserve History: 1978–79 oil shock.
- Federal Reserve History: Great Inflation.
- Federal Reserve History: Volcker measures.
- US Energy Information Administration: Iran supply loss.
- Reserve Bank of India: 1970s price pressures.
- IMF: why later shocks may differ.
- Federal Reserve: shifting short-run and vertical long-run curves.
- San Francisco Fed: supply shocks and expectations in the 1970s.
QUICK CHECK 5 OF 6 · TRUE OR FALSE
Any rise in oil prices means the economy already has stagflation.
A price jump raises risk. Check inflation, growth, and jobs over time before using the label.
QUICK CHECK 6 OF 6 · TRUE OR FALSE
A supply shock can make prices rise even while output and hiring weaken.
Costlier energy can raise production costs and cut spending. Both effects can happen together.
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