The Seventies

Scott Sumner  points out that since real GDP grew approximately 3% over the decade of the seventies, the reason for the high and rising inflation during that decade was the high and rising growth rate of nominal GDP.   In my view, Sumner's argument made perfect sense as a response to criticisms of Market Monetarism.   Market Monetarists argue that nominal GDP should be targeted and inflation ignored.   Some have responded by expressing concern that this would allow inflation to get out of control-- like in the seventies.     But the problem in the seventies was rapid growth in nominal GDP.   Like usual, Marcus Nunes provides helpful diagrams.  


Karl Smith argues that real GDP isn't important, it is the unemployment rate, which was quite high during all of the decade and reached 9% in the 73-74 recession.   Yichuan Wang argues that the accelerating growth of nominal GDP illustrated by Nunes should have resulted in more rapid growth in real GDP.    If real GDP only grew approximately 3%, there must have been some offsetting adverse supply shocks.   David Glasner provides an historical account of the decade, including accelerating inflation expectations and two increases in oil prices as significant adverse supply shocks.  

I decided to take a look at real GDP relative to the CBO estimate of potential GDP.

What is striking is that potential GDP looks very steady.  Other than that, there is a boom, bust, and slow recovery.    Not much room for supply-side decreases in productive capacity.    The growth rate diagram is below:

Like real GDP, as noted by Sumner, the CBO estimate of potential real GDP averaged close to 3 percent growth and really had very little fluctuation.

Here is the CBO estimate of potential output along with a linear trend from 1948 to 2012.

This shows that potential output was above its trend during the seventies.   Of course, it is obvious from the diagram that the growth rate of potential output is decreasing.    Still, if that trend is superimposed on real GDP and potential, real GDP remains above the trend of potential during the entire period.

If we had nominal GDP targeting during the period, at 5%, or better yet, at 3%, then the increases in the price of imported oil would have raised the price level and inflation rate.   The prices of imports don't directly impact nominal GDP.   Given the growth path of potential output, the prices of domestically produced goods would have grown slowly, 2% with the 5% nominal GDP growth path, or not at all, with the 3 % growth path.

Of course, maybe the CBO estimates of potential output are wrong.