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Economics U$A: 21st Century Edition

Inflation (Macroeconomics)

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In the 1960s President Lyndon Baines Johnson continued fueling the domestic agenda of his “Great Society,” keeping a low profile on the Vietnam War. But the U.S. overspent and inflation bubbled over. Anyone living on a marginally fixed income endured harsh consequences under inflation, and workers’ strikes only brought costs up more. After his election in 1972, Richard Nixon ordered a 90-day nationwide price and wage freeze after the Federal Reserve failed to curb inflation. These stories show problems posed by the development of inflation in the post-war U.S. economy.

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Unit Overview

Purpose:

To show the gradual development of inflationary pressures in the postwar U.S. economy, and to show why these pressures posed problems for policymakers and also for Keynesian economics.

Objectives:

  1. By inflation, we mean a general rise in the overall price level as measured by a price index, say the Consumer Price Index (CPI).
  2. Inflation, especially unexpected inflation, imposes costs on the economy. These costs include:
    • distortions in the tax system;
    • gains by debtors and losses by creditors;
    • increased uncertainty;
    • losses by people with fixed incomes.
  3. In the 1960s and 1970s, inflation became a problem principally because the economy was operating close to or at the vertical portions of the aggregate supply curve. This meant that boosts to aggregate demand, through stimulative fiscal policy, not only raised growth, but also raised prices.
  4. Because the ideas of Keynes were conceived at a time when the world economy was in a depression, he was not overly concerned with the problems of inflation. Keynesian economics implicitly assumed a flat aggregate supply curve.
 When an economy is not in a depression or recession, monetary influences in the economy, both on GDP/GNP and prices, become more important. Also, inflation expectations can play an important role. These subjects were given little attention by most of Keynes’s followers.

Meet the Series Experts

Paul McCracken

Chairman of President Richard Nixon’s Council of Economic Advisers (CEA), now the Edmund Ezra Day Distinguished University Professor Emeritus of Business Administration, Economics, and Public Policy at the University of Michigan. He chaired the American Enterprise Institute’s Council of Academic Advisors and served as interim president of the Institute in 1986. As Chairman of the CEA, McCracken pursued economic policies of restraint to curb inflation without increasing unemployment. He opposed a revival of mandatory wage and price controls, favored by some economists. He often appeared in conflict with the Federal Reserve respecting monetary policy, favoring a more liberal policy than the Federal Reserve had been willing to allow. Dr. McCracken received his B.A. from William Penn College and his M.A. and Ph.D. in Economics from Harvard University.

Walter Heller

Influential American economist of the 1960s and Chairman of President John F. Kennedy’s Council of Economic Advisers, 1961–1964. He was a Keynesian who promoted cuts in the marginal federal income tax rates, which were passed by President Johnson and Congress after Kennedy’s death and credited for boosting the economy. He developed the first “voluntary” wage-price guidelines and was one of the first to emphasize that tax deductions and tax preferences narrowed the income tax base. As adviser to President Johnson, he convinced the president to adopt a major economic initiative—the “War on Poverty.” But he resigned when Johnson escalated the Vietnam War without raising taxes, thus setting the stage for an inflationary spiral. Before and after government service, he taught at the University of Minnesota where he became Chair of the Department of Economics. Mr. Heller received his B.A. from Oberlin College.

Victor Gotbaum

American labor leader who was President of AFSCME District Council 37 (DC37), the largest municipal union in New York City, from 1965 to 1987. Under Gotbaum’s leadership, DC37 successfully organized thousands of municipal hospital workers and helped create New York City’s Office of Collective Bargaining. During the New York City bankruptcy crisis in the mid-1970s, Gotbaum and DC37 agreed to major collective bargaining concessions, which set a pattern that forced other municipal unions to do the same. He fought in World War II, attended Brooklyn College and the School of International and Public Affairs at Columbia University, and took his first union job as assistant director of the Amalgamated Meat Cutters in Chicago, in 1955.

What's your Economics IQ?

Take the Economics USA: Inflation Quiz here.

Quiz Addendum:

5. Based on the diagram below, we can conclude that the maximum national output and employment will occur when the economy is operating in:

Answer:

 

 

 

 

Range C.

Glossary

  • aggregate demand curve
    A curve, sloping downward to the right, that shows the level of real national output that will be demanded at various economy-wide price levels.
  • aggregate supply curve
    A curve, sloping upward to the right, that shows the level of real national output that will be supplied at various economy-wide price levels.
  • cost of living adjustments
    COLA. An annual adjustment in wages to offset a change (usually a loss) in purchasing power, as measured by the Consumer Price Index.
  • demand-side inflation
    An increase in the general price level that occurs because of rightward shifts of the aggregate demand curve. There is too much aggregate spending, too much money chasing, too few goods.
  • inflation expectations
    Rate of inflation that workers, businesses, and investors think will prevail in the future, and that they will therefore factor into their decision making.
  • monetary policy
    The exercise of the central bank’s control over the quantity of money and the level of interest rates in order to promote the objectives of national economic policy.
  • supply shock
    An event that suddenly changes the price of a commodity or service.

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Economics U$A: 21st Century Edition

Credits

Produced by the Educational Film Center. 2012.
  • Closed Captioning
  • ISBN: 1-57680-895-5