Before heeding the call of Keynesian demand-management, a look at the stagflation of the 1970s can teach us a great deal about its policy failures and successes.
At that time, fiscal profligacy had not reached today’s astronomic proportions, but the demand-boosting so dear to Keynesians was ensured by countless waves of wage hikes throughout the industrialized world. Along with increases in commodity prices, these were the main source of inflation at the time.
Federal Reserve chairman Paul Volcker then entered then the scene, bringing with him a monetary policy whose purpose was not to inundate the economy with liquidity (as is the case today), but to curb monetary emissions to stifle inflation. Contrary to expectations, that policy produced the worst recession of the post-War period.
Fortunately, a policy revolution was in the making – one involving so-called supply-side measures aimed at removing the constraints that were inhibiting firms that wanted to invest and hire. Tax rates were significantly reduced. Labor legislation was revised to allow firms to reduce the labor force when shrinking sales made it necessary or profitable.
The supply-side revolution was a politically painful exercise. It encountered strong opposition from powerful vested interests, in particular trade unions. It took the courage of Margaret Thatcher, and subsequently of Ronald Reagan, to stand firm in the face of multiple, long-lasting strikes. Ultimately, thanks to the determination of Thatcher and Reagan – and of their acolytes in other countries – the world economy entered a period of unprecedented growth and modernization.