“The oil shock of 1973 established the importance of monetary policy as the dominant tool in the fight against inflation”

Lhe oil shock of 1973 led to an economic crisis in developed economies, the consequences of which put an end to thirty years of prosperity, growth and full employment. In France, the unemployment rate doubled between 1974 and 1980; the inflation rate rose from 6.2% in 1972 to 13.6% in 1980. This is the specificity of this crisis: while the previous ones were associated with deflation, the oil shock led to an unprecedented situation: the combination high inflation and unemployment, popularized under the concept of “stagflation”.

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Furthermore, the crisis is accompanied by a slowdown in the growth rates of industrial production and a sharp increase in budget deficits in industrial countries. These deleterious effects of the oil shock were amplified by a monetary rupture due to the abandonment, on August 15, 1971, of the convertibility of the dollar into gold, which led to the floating of currencies and opened an era of instability in exchange rates.

To remedy stagflation, successive governments alternate between austerity and recovery, the famous stop and go. In France, the Fourcade plan (1974) and the Chirac relaunch (1975) followed one another. From 1976, Raymond Barre’s austerity policy blocked purchasing power, but production costs continued to increase, so that unemployment and inflation persisted. In 1979, the second oil shock increased the external deficit and inflation, while the number of unemployed passed the 2 million mark.

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It is above all the economic theory of John Maynard Keynes [1883-1946]who analyzed the crises of the early 20th centurye century as a trade-off between inflation and unemployment, modeled by the Phillips curve (named after Alban Phillips, New Zealand economist, in a 1958 article), which is undermined by stagflation. Monetarist economists like Milton Friedman criticize the excesses of Keynesianism, which would have led to a monetary glut, the main cause, according to them, of the inflation of the 1970s. They show that the trade-off between inflation and unemployment is only valid short term.

The triumph of the neoclassics

Faced with an expansionary monetary policy, economic agents would be victims of a “monetary illusion” in the short term and would moderate their wage demands, which would allow a temporary reduction in unemployment. But, in the medium term, the illusion would dissipate and the unemployment rate would return to its equilibrium level with, as a bonus, higher inflation. Neoclassical economists go even further, and assume that agents form rational expectations: they cannot be lured by monetary policy, even in the short term, and the latter would become ineffective.

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