Debunking Supply Shock Myth

The seeds of the 1970s’ stagflation were sown during the overheated economy of the late 1960s

Inflation is high at present. Assessing to what extent this is due to demand overheating or supply shocks is essential to formulating suitable policy responses. This requires delving into past data and debate. A prominent view is that inflation in 1974-75 and 1979 was caused by Opec (Organization of Petroleum Exporting Countries) supply shocks. Leading macro texts state that the huge, unexpected rise in unemployment and inflation in 1974 worldwide was due to Opec

To evaluate what happened, let us review the basic facts as generally perceived. In October 1973, following the Arab-Israeli conflict, Opec raised the price of a barrel of crude oil, then at $3, almost fourfold. By 1975, the world economy slowed the most since the Great Depression, with Japan