The Federal Reserve is Repeating Their 1970s Mistakes

From the vantage point of policymakers in the Federal Reserve, the 1973-74 oil crisis served to further complicate the macroeconomic environment, particularly in regard to inflation. Fed Chairman Burns argued in 1979 that the inflation appeared to be the result of a plethora of forces: “the loose financing of the war in Vietnam. . .the devaluations of the dollar in 1971 and 1973, the worldwide economic boom of 1972-73, the crop failures and resulting surge in world food prices in 1974-75, and the extraordinary increases in oil prices and the sharp deceleration of productivity” (Burns 1979). The intellectual consensus among policymakers at the time was that cost-push inflation (the type of inflation arising from an increase in the prices of inputs to the economy, i.e., worker wages) was outside the influence of monetary policy (Romer and Romer 2012). In the words of an economist who presented to the Federal Open Market Committee in May of 1971, “the question is whether monetary policy could or should do anything to combat a persisting residual rate of inflation ... The answer, I think, is negative. ... It seems to me that we should regard continuing cost increases as a structural problem not amenable to macro-economic measures” (Romer and Romer 2012).

Economists have since come to understand that a central bank can influence the extent to which supply shocks affect inflation, but they face a trade-off. Higher oil prices, because of the widespread effect they have on commodities throughout the economy, will tend to generate both inflationary pressures and slower growth. In the short run, these forces tend to have an inverse relationship, meaning when one rises, the other falls and vice versa. Ben Bernanke for example, discussed this in 2004: “How then should monetary policy react? Unfortunately, monetary policy cannot offset the recessionary and inflationary effects of increased oil prices at the same time. If the central bank lowers interest rates in an effort to stimulate growth, it risks adding to inflationary pressure; but if it raises enough to choke off the inflationary effect…it may exacerbate the slowdown in economic growth.” He goes on to explain that the decision to tighten or ease monetary policy ultimately depends on how policymakers balance the risks inherent in pursuing employment and price stability objectives (Bernanke 2004).

Ultimately, the oil crisis of 1973 and the accompanying inflation was a result of many factors culminating in a perfect economic storm. The oil embargo of 1973 was just one of many complicating factors that led U.S. policymakers to overestimate our national potential and to underestimate their own role in the broad inflation that occurred throughout the 1970s.

Since we know the history, we know that printing money to try to offset recession is impossible. It creates higher inflation that results in a larger recession down the road. The DJIA fell 46 percent from its all-time high in January 1793 to its November 1974 low with only brief rallies, the longest being a 3-month, 17-percent rebound in 1973.

It isn't certain yet what is comingin the near term because of the debt bubble. Prior tapers have also triggered sell-offs. The question is will the Fed allow a deep sell-off or will it use omicron, Chinese port closures or whatever excuse is at hand to pump as it did in 1973? If yes, the Federal Reserve will eventually raze Wall Street and the wider financial sector.