the essence of demand-pull inflation is too much money chasing too few goods and that is exactly what happened when the u.s. tried to finance both guns and butter both the Vietnam War and the Great Society this situation is illustrated in this figure during wartime increased defense spending moves aggregate demand from ad to ad prime an equilibrium output increases from E to e prime as real GDP expands however when real output Rises far above potential output the price level moves up sharply as well from P to B Prime in 1972 President Richard Nixon imposed price and wage controls and gained the nation a brief respite from the Johnson era inflation however once the controls were lifted in 1973 inflation jumped back up to double digits helped in large part by a different kind of inflation than emerging an inflation known as cost-push or supply-side inflation cost-push or supply-side inflation occurs when factors such as rapid increases in raw material prices or wage increases drive up production costs this can happen as a result of so-called supply shocks such as those experienced in the early 1970s during this period such shocks included crop failures a worldwide drought and a quadrupling of the world price of crude oil this cost-push situation in the 1970s is illustrated in this figure sharply higher oil commodity and labor costs increased the cost of doing business in the ASAT framework the higher costs shift the a s curve up from a s to a s Prime and the equilibrium shifts from E to e prime output declines from Q to Q Prime while prices rise this leads to the phenomenon of stagflation recession or stagnation combined with inflation in this situation the economy suffers the double whammy of both lower output and higher prices prior to the 1970s economists didn’t believe you can even have both high inflation and high unemployment at the same time one went up the other had to go down the 1970s proved economists wrong on this point and likewise exposed Keynesian economics as being incapable of solving the new stagnation problem Keynesian dilemma was simply this using expansionary policies to reduce unemployment simply created more inflation while using contractionary policies to curb inflation only deepen the recession that meant that the traditional Keynesian tools could solve only half of the stagflation problem at any one time and only by making the other half worse it was this inability of Keynesian economics to cope with stagflation that set the stage for professor Milton Friedman’s monetarists challenge to what had become the Keynesian orthodoxy built in Friedman’s monetary school argued that the problems of both inflation and recession may be traced to one thing the rate of growth of the money supply through the monetarist inflation happens when the government prints too much money and recessions happen when it prints too little from this monetarist perspective stagflation is the inevitable result of activist fiscal and monetary policies that try to push the economy beyond its so-called natural rate of unemployment or more technically its lowest sustainable unemployment rate this natural rate of unemployment or LSU are is the lowest level of unemployment that can be attained without upward pressure on inflation according to the monetarist expansionary attempts to go beyond this lowest sustainable unemployment rate may result in short run spurts of growth however after each growth spurt prices and wages rise and drag the economy back to its LS you are albeit at a higher rate of inflation over time these futile attempts to push the economy beyond its lowest sustainable unemployment rate lead to an upward inflationary spiral in this situation monetarists believed that the only way to wring inflation and inflationary expectations out of the economy is to have the actual unemployment rate rise above the LS you are and that means only one thing inducing a recession this is at least one interpretation of what the Federal Reserve did beginning in 1979 under the monetarist banner of setting monetary growth targets under Chairman Paul Volcker the Fed adopted a sharply contractionary monetary policy and interest rates soared to over 20 percent particularly hard-hit were interest sensitive sectors of the economy like housing construction automobile purchases and business investment while the feds bitter medicine worked three years of hard economic times left a bitter taste in the mouths of the American people now hungry for a sweeter macroeconomic cure then either the Keynesian x’ or monetarists could offer an her stage right supply-side economics

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