How the Great Inflation of the 1970s Happened

It's the 1970s. The stock market is a mess. It has lost nearly 50% of its value over a 20-month period. For close to a decade few people want anything to do with stocks. Economic growth is weak, which results in rising unemployment that eventually reaches double digits.

The easy money policies of the American central bank were meant to generate full employment by the early 1970s. Unfortunately, they also resulted in high inflation.

Under different leadership, the Federal Reserve System would later reverse its policies, raising interest rates to some 20%. This level was once considered usurious. For interest-sensitive industries, such as housing and automotive, rising interest rates can cause a calamity, with many people priced out of new homes and cars.

Key Takeaways

  • Rapid inflation occurs when the prices of goods and services suddenly rise, eroding the purchasing power of savings.
  • The 1970s saw some of the highest rates of inflation in the United States in recent history.
  • In turn, interest rates rose to nearly 20%.
  • Fed policy, the abandonment of the gold window, Keynesian economic policy, and market psychology all contributed to the high inflation.
  • Lower inflation would return only after a tough period of tight money and recession.

The Great Inflation of the 1970s

Overall, the macroeconomic event referred to as the Great Inflation lasted from 1965 to 1982. This is the story of the painful period in the 1970s, which began in late 1972 and continued until the early 1980s. In his book, Stocks for the Long Run: A Guide for Long-Term Growth, Wharton professor Jeremy Siegel called this time "the greatest failure of American macroeconomic policy in the postwar period."

The Great Inflation was blamed on oil prices, currency speculators, greedy businessmen, and avaricious union leaders. However, it is clear that monetary policies that financed massive budget deficits and were supported by political leaders were the cause.

This mess was proof of what Milton Friedman wrote about in his book, Money Mischief: Episodes in Monetary History. Inflation is always "a monetary phenomenon."

The Great Inflation and the recession that followed ruined many businesses and hurt countless individuals. Interestingly, John Connally, the Nixon-installed Treasury Secretary with no formal economics training, later declared personal bankruptcy.

Yet these unusually bad economic times were preceded by a period in which the economy boomed, or appeared to boom. Many Americans were awed by the temporarily low unemployment and strong growth numbers of 1972.

Therefore, in 1972, they overwhelmingly re-elected their Republican president, Richard Nixon, and their Democratic Congress. Nixon, the Congress, and the Fed eventually ended up failing them.

Causes of the Great Inflation

Upon his inauguration in 1969, Nixon inherited a recession from Lyndon Johnson, who had simultaneously spent generously on the Great Society and the Vietnam War.

Despite some protests, Congress went along with Nixon to continue to fund the war and increase social welfare spending. In 1972, for example, Congress and Nixon agreed to a big expansion of Social Security—just in time for the elections.

Nixon's Changing Viewpoint

Nixon came to office as a supposed fiscal conservative. Yet, one of his advisors would later classify Nixonomics as "conservative men with liberal ideas." Nixon ran budget deficits, supported an income policy, and eventually announced that he was a Keynesian. 

John Maynard Keynes was an influential British economist of the 1930s and 1940s. He advocated revolutionary measures. For instance, he believed that governments should use countercyclical policies in hard times, running deficits in recessions and depressions.

Before Keynes, governments during difficult economic periods generally had balanced budgets and waited for badly allocated business investments to liquidate. The object was to allow market forces to bring about a recovery naturally.

Nixon's other economic about-face occurred when he imposed wage and price controls in 1971. Again, these actions seemed to work during the following election year. Later on, however, they would fuel the fires of double-digit inflation. Once they were removed, individuals and businesses tried to make up for lost ground.

Nixon's deficits were also making dollar-holders abroad nervous. There was a run on the dollar, which many foreigners and Americans thought was overvalued. Soon they were proved right.

In 1971, Nixon broke the last link to gold, turning the American dollar into a fiat currency. The dollar was devalued, and millions of foreigners holding dollars, including oil barons in the Middle East with tens of millions of petrodollars, saw their value slashed. 

Election Year Politics

Still, President Nixon's primary concern was not dollar holders or deficits or even inflation. He feared another recession. He and others who were running for re-election wanted the economy to boom. The way to do that, Nixon reasoned, was to pressure the Fed to lower interest rates.

Nixon fired Fed chair William McChesney Martin and installed presidential counselor Arthur Burns as his successor in early 1970.

Although the Fed is supposed to focus solely on money creation policies that promote growth without excessive inflation, Burns was quickly taught the political facts of life. Nixon wanted cheap money. That meant low interest rates to promote growth in the short term and make the economy seem strong as voters went to cast their ballots.

Note

Richard Nixon would be forced to resign from the presidency in August 1974, as a result of his proven connection to the scandal involving the break-in at the headquarters of the Democratic National Committee at the Watergate Office Building in Washington, D.C.

Results of Cheap Money

In public and private, Nixon put the pressure on Burns. William Greider, in his book, Secrets of the Temple: How the Federal Reserve Runs The Country, reports Nixon as saying, "We'll take inflation if necessary, but we can't take unemployment." The nation eventually had an abundance of both. Burns and the Fed's Open Market Committee, which decided on money creation policies, soon provided cheap money.

The key money creation number, M1, consists of total checking deposits, demand deposits, and traveler's checks. It grew from $228 billion to $249 billion between December 1971 and December 1972, according to Federal Reserve Board numbers.

As a matter of comparison, in Fed chair Martin's last year, M1 grew from $198 billion to $206 billion. M2, which measures retail savings and small deposits, grew even more by the end of 1972, from $710 billion to $802 billion.

Adding to the money supply worked in the short term. Nixon carried 49 out of 50 states in the election. Democrats easily held Congress. Inflation was in the low single digits. However, the country paid the price in higher inflation once the election year festivities ended.

In the winters of 1972 and 1973, Burns began to worry about inflation. In 1973, inflation more than doubled to 8.8%. Later in the decade, it would go to 12%. By 1980, inflation was at 14%. Was the United States about to become another, post-WWI Weimar Republic experiencing the brutal effects of crippling inflation? Some actually thought that the era of the great inflation was a good thing.

The Great Inflation period would finally come to an end once later Fed chair Paul Volcker pursued a bold but painful contractionary money policy to control it.

What Is Inflation?

While prices for individual products fluctuate all the time, inflation refers to the ongoing rise in the prices of a broad group of goods and services over time and the resulting loss of purchasing power. Consumers get less for every dollar they spend than they received before inflation occurred.

What Was the Great Inflation of the 1970s?

The period in the 1970s and extending into the early 1980s referred to as the Great Inflation was a time of rising inflation. The inflation rate, as measured by the consumer price index, rose to as high as 14% in 1980. Federal Reserve policies that promoted a large increase in the money supply are considered the main reasons for the Great Inflation.

How Did the Great Inflation Affect Americans?

The steady and lasting rise in prices seen during the Great Inflation created a time of tremendous and disturbing instability for Americans. With the accompanying loss of purchasing power, the risk that the savings of many would be depleted was real.

People found it difficult and dismaying to plan for purchases from week to week. They had to make unpleasant choices about which needed items to buy. Certain items simply were out of reach for many. The deeply unsettling effect of inflation eroded their confidence in their standard of living and in the country's leadership.

The Bottom Line

It would take another Fed chair and a brutal policy of tight money—including the acceptance of a recession—before inflation would return to low single digits. In the meantime, the U.S. would endure jobless numbers that exceeded 10%. Millions of Americans were infuriated and suffering by the late 1970s and early 1980s.

Yet, few remember Fed chair Burns, who in his memoirs, Reflections of an Economic Policy Maker (1969-1978), blames others for the Great Inflation without mentioning the disastrous monetary expansion. Nixon didn't even mention this central bank episode in his memoirs. Many people who remember this terrible era blame it on Arab countries and oil pricing.

Still, The Wall Street Journal, when reviewing this period in January 1986 wrote, "OPEC got all the credit for what the U.S. had mainly done to itself."

Article Sources
Investopedia requires writers to use primary sources to support their work. These include white papers, government data, original reporting, and interviews with industry experts. We also reference original research from other reputable publishers where appropriate. You can learn more about the standards we follow in producing accurate, unbiased content in our editorial policy.
  1. Macrotrends. "Dow Jones - DJIA - 100 Year Historical Chart."

  2. Federal Reserve Bank of St. Louis. "Gross Domestic Product."

  3. U.S. Bureau of Labor Statistics. "Unemployment continued to rise in 1982 as recession deepened," Page 4.

  4. Federal Reserve Bank of St. Louis. "The Great Inflation: A Historical Overview and Lessons Learned."

  5. Board of Governors of the Federal Reserve System. "Inflation Dynamics and Monetary Policy - Figure 1."

  6. Federal Reserve Bank of St. Louis. "TIMELINE: Federal Reserve Chair."

  7. Federal Reserve Bank of St. Louis. "Effective Federal Funds Rate."

  8. Federal Reserve History. "The Great Inflation."

  9. InflationData.com. "Historical Inflation Rate."

  10. Jeremy Siegel et al. "Issues for Debate in Social Policy: Selections From CQ Researcher," Page 408, Sage Publications, 2019.

  11. Milton Friedman. "Money Mischief: Episodes in Monetary History," Page xi. HMH, 1994.

  12. The National Bureau of Economic Research. "US Business Cycle Expansions and Contractions."

  13. Enclyclopaedia Brittanica. "John Bowden Connally, Jr."

  14. Social Security Administration. "Legislative History - 1972 Social Security Amendments."

  15. Herbert Stein. "Presidential Economics," Page 139. American Enterprise Institute for Public Policy Research, 1994.

  16. Miller Center. "RICHARD NIXON - KEY EVENTS."

  17. Congressional Budget Office. "Incomes Policies in the United States: Historical Review and Some Issues," Page 29.

  18. U.S. Department of State. "Nixon and the End of the Bretton Woods System, 1971–1973."

  19. Federal Reserve Bank of Minneapolis. "Remembering William McChesney Martin Jr."

  20. Federal Reserve History. "Arthur F. Burns."

  21. William Greider. "Secrets of the Temple: How the Federal Reserve Runs the Country." Simon and Schuster, 1989.

  22. Federal Reserve Bank of St. Louis. "M1 Money Stock."

  23. Federal Reserve Bank of St. Louis. "M2 Money Stock."

  24. Federal Reserve History. "Volcker's Announcement of Anti-Inflation Measures."

  25. William Greider. "Secrets of the Temple: How the Federal Reserve Runs the Country," Page 340. Simon and Schuster, 1989.

Take the Next Step to Invest
×
The offers that appear in this table are from partnerships from which Investopedia receives compensation. This compensation may impact how and where listings appear. Investopedia does not include all offers available in the marketplace.
Service
Name
Description