In a recent post I pointed out that during the 1970s we had normal (3.2%) growth and that 100% of the high inflation was due to NGDP growth being much higher than 5%, indeed about 10.4% on average between 1970 and 1980. So even during the 1970s, inflation would have been only around 1.8% under NGDP targeting. I think Karl Smith accepts that argument. But he also claims:
The 1970s were definitely an era of stagflation
He later defends this statement by pointing to the relatively high levels of unemployment during that decade. I had thought the word ‘stagflation’ meant high inflation plus slow output growth (due to slow growth in AS.) Karl seems to think it means high inflation plus other bad things, like high unemployment.
Rather than arguing over semantics, I’d rather focus on the important issue; what does the 1970s tell us about NGDP targeting? I think Karl and I would both agree that (whether or not there was stagflation during the 1970s) under 5% NGDP targeting there definitely would not have been any stagflation. The 1970s are not a counterexample to my claim that 5% NGDP targeting would produce good results for those variables that central banks can affect.
It’s true that we could have done better on the supply-side with improved public policies during the 1970s, which would have led to more rapid growth. But that’s also true of the 1950s and 1960s, when more lenient immigration laws would have produced faster growth. It’s always true that RGDP is well below the level that would have occurred with better public policies. But I think if the term ‘stagflation’ is going to mean anything useful, it has to refer to a periods where, for any given rise in AD, slower than normal AS growth leads to higher inflation. The 1970s do not meet that definition.
I agree with Karl that changes in the unemployment rate are a better indicator of the business cycle than changes in RGDP. But I hope that we can both agree that slow growth in AS did not cause the high inflation of the 1970s. Yes, the natural rate of unemployment rose by about 2% during the 1970s, but any inflationary impact of that increase was offset by faster than normal growth of the labor force. Hence inflation was completely demand-side.
I agree that oil shocks, considered in isolation, raised the price level during the 1970s. But the impact of higher oil prices was more than offset by the impact of faster than normal labor force growth. Hence the supply-side of the economy did not have any inflationary impact on the economy in the 1970s. Our textbooks are wrong, just as they are wrong when they tell our students that the classical economists believed the AS curve was vertical. Or that Fisher believed velocity was constant. Or . . . but it would take too long to list all the errors.
PS. I do agree the term ‘stagflation’ applies to 1974.
PPS. In the comment section of my earlier post Numeraire makes some points that are similar to those of Karl Smith.
Update: Tim Duy sent me a very good post he did last year that makes some similar points, and includes some graphs comparing the 1970s to the past decade.