As our economy slows and inflation remains stubbornly high, one must wonder if we will ever learn our lessons. We have been here before and we know what causes this, yet here we are once more. We did not learn the lesson of the 1970s; but why?
Macroeconomists are too fixated on aggregate demand. They believe that if aggregate demand is stimulated – through low interest rates or government spending – then supply will simply react. Supply didn’t react in the 1970s, and it is not reacting now; hence, inflation.
In the 1970s the Fed raised interest rates to lower aggregate demand, but then policymakers countered that action. For example, Nixon implemented price controls, which actually stimulated demand while curtailing supply. The result was shortages; growth slowed further, and inflation persisted.
The Fed did eventually raise rates again and kill inflation, but they had the help of the Carter and Reagan administrations, which both freed up supply through regulatory and tax reform. That is what it took then, and that is what is needed now.
“Those that fail to learn from history are doomed to repeat it.” ~ Winston Churchill
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