The 1973-1975 Recession: A Lesson in Market Intervention and Government Missteps

The government's economic policies and other factors contributed to a recession from 1973-1975.

Government Economic Missteps contributed to the 1973-1975 recession.
An AI-generated images of a political, economic speech.

As we reflect on the annals of American economic history, the 1973-1975 recession stands out as a stark reminder of the consequences of government intervention and the importance of free market principles.

The mid-1970s marked a significant economic downturn that saw soaring inflation, increasing unemployment, and declining gross domestic product (GDP). This period, often referred to as "stagflation," challenged conventional economic wisdom and now serves as an example of the dangers of ignoring the fundamental principles of a free market economy.

Seeds of the 1973-1975 Recession

The roots of the 1973-1975 recession took hold during the 1960s and early 1970s when government policies fostered an inflationary environment in the United States.

President Lyndon B. Johnson's ambitious "Great Society" programs and the costly Vietnam War placed enormous pressure on the nation's fiscal resources. To support these initiatives, the Federal Reserve engaged in monetary expansion, with consequences that would reverberate throughout the economy for years to come. This policy decision led to a disconnect between the money supply and the country's productive capacity, causing economic instability.

Milton Friedman, in his 1968 presidential address to the American Economic Association, foresaw the potential consequences of the Federal Reserve's policies, warning that the Fed's attempts to control inflation and unemployment by manipulating the money supply were doomed to fail, as they disregarded the inherent complexities of the labor and commodity markets.

The misalignment of the money supply with the economy's productive capacity drove inflation, which built up in the late 1960s and early 1970s was the direct result of the Fed's attempts to reconcile the domestic and international monetary policy objectives. According to some retrospectives, the United States would have had to reduce the growth of the money supply and accept a slower rate of domestic economic expansion to avoid or mitigate the problem of rising inflation.

"The main lesson from the 1970s is that that kind of nagging, persistent, recurring double-digit inflation doesn't happen overnight. It sets in over many years, and it set in because of a long series of policy mistakes in Washington," said economic journalist Jon Hilsenrath in a  2022 video report from The Wall Street Journal.

Put simply, massive public spending lead to inflation and a rising cost of living.

The Wall Street Journal describes inflation leading up to the 1973 recession.

The Nixon Administration's Response to Inflation

If President Johnson's policies planted the seeds of the 1973-1975 recession, then President Richard Nixon's monetary policy watered,  nurtured, and cultivated those seeds.

The United States stopped backing the dollar with gold on August 15, 1971, when President Richard Nixon announced the "Nixon Shock." This decision effectively ended the convertibility of the U.S. dollar into gold and marked the end of the Bretton Woods system, an international monetary system that had been in place since 1944.

Under the Bretton Woods system, the U.S. dollar was pegged to gold at a fixed exchange rate of $35 per ounce, and other major currencies were pegged to the U.S. dollar.

The Nixon "Bretton Woods" or "Nixon Shock" speach from August 15, 1971 via the Richard Nixon Presidential Library. 

Nixon decided to suspend the gold convertibility in response to rising inflation, mounting U.S. trade deficits, and increasing pressure on the U.S. gold reserves as foreign countries sought to exchange their dollars for gold. And this decision was only the first to feed the recession.

The Nixon administration confronted the inflation crisis by implementing price and wage controls to contain the escalating costs of goods and services. However, these measures had unintended consequences, suppressing market forces and leading to extensive shortages and inefficiencies. For instance, gasoline price controls resulted in long lines at gas stations and fuel rationing. The controls failed to tackle the underlying causes of inflation but also worsened the situation by disrupting the natural balance of supply and demand.

The Oil Crisis and its Impact on the Economy

As inflation surged in the United States, the price of oil followed suit, reaching a boiling point with the 1973 oil crisis. The Organization of the Petroleum Exporting Countries (OPEC) imposed an oil embargo in response to the United States' support for Israel during the Yom Kippur War. This embargo drastically impacted oil prices, with the price per barrel quadrupling in a matter of months. The oil shock sent ripples through the U.S. economy, driving up the cost of goods and services and exacerbating the already troublesome inflation issue.

The Economist looks at what drove the energy crisis in 1973 and what we can learn from it right now, including how the Russian-Ukraine war is similar.

Phillips Curve in the 1970s Stagflation

The "Stagflation" of the 1970s was further aggravated by the prevalent economic theory at the time, the "Phillips Curve," which suggested a trade-off between inflation and unemployment. Policymakers tried to counteract the effects of high inflation by increasing government spending and adopting loose monetary policy.

However, these actions only served to fan the flames of inflation without reducing unemployment. The misguided application of the Phillips Curve ultimately revealed that short-term fixes and manipulation of market forces could not substitute for the significance of prudent fiscal and monetary policy.

Look Back at the 1973-1975 Recession

The 1973-1975 recession was a critical turning point in American economic history, serving as a wake-up call for policymakers and economists alike. It was a period of economic distress that highlighted the dangers of government intervention and the importance of allowing market forces to operate freely.

In the years that followed, the United States saw a resurgence of conservative economic thought, advocating for the principles of free markets, limited government intervention, and sound monetary policy. Economists like Milton Friedman and Thomas Sowell emerged as key figures in this movement, promoting the importance of a laissez-faire approach to economics.

As we navigate the challenges of the modern global economy, it is vital to remember the lessons of the 1973-1975 recession. It serves as a stark reminder that government intervention can often do more harm than good and that a thriving economy is built on the foundation of free markets and sound fiscal policy.

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