The first oil crisis started with the oil embargo proclaimed by OPEC.
OPEC: Oil exporting nations accumulated vast wealth due to the price increase. US: the oil price increase induced the recession, inflation, reduced productivity, and low economic growth.
Whyt did Keynesian economics fail in the 1970s?
According to Keynesians, the growth in the money supply can increase employment and promote economic growth. Keynesian economists believe in the Philips relationship between unemployment (economic growth) and inflation. However, both of them hiked in the 1970s.
Why did stagflation occur?
The prevailing belief has been that high levels of inflation were the result of an oil supply shock and the resulting increase in the price of gasoline, which drove the prices of everything else higher (cost-push inflation).
A now well-founded principle of economics is that excess liquidity in the money supply can lead to price inflation. Monetary policy was expansive during the 1970s, which could help explain the rampant inflation at the time.
How did Friedman work?
“Inflation is always and everywhere a monetary phenomenon.”
Milton Friedman
During the energy crisis of the 1970s, while everyone was blaming OPEC in the early part of the 70s, or the Iranian revolution in 1979, Friedman recognized who the real culprits were — Richard Nixon, who in 1973 instituted wage-price controls and, following Nixon, Gerald Ford and Jimmy Carter who continued these price controls on oil, gasoline, and natural gas.
“The present oil crisis has not been produced by the oil companies. It is a result of government mismanagement exacerbated by the Mideast war.”
– Milton Friedman, “Why Some Prices Should Rise,” Newsweek, November 19, 1973.
Friedman believed prices could not increase without an increase in the money supply. The Fed followed a constrictive monetary policy that helped drive interest rates to double-digit levels, reduce inflation.
P.S. Fed’s credibility and inflation expectation (inflation targets) also play roles in resulting in stagflation.
Inspiration
Inflation (or hyperinflation) is a monetary phenomenon by Friedman and some economists. In China’s case, stagflation seems unable to happen if there are no vast increase in money supply and loss of credibility of the central bank.