We're told that the 1970s proved Keynesian economics failed, that inflation and unemployment could rise together, and only neoliberalism could fix it. But the truth is very different. External shocks, not excessive spending, drove that crisis. Governments panicked, misunderstood money, and abandoned Keynes when they needed him most.
In this video, I unpack what really caused stagflation — and why repeating those mistakes today risks another lost decade for Britain.
This is the audio version:
This is the transcript:
Some people are saying that we face the risk of 1970s-style stagflation in the UK, where inflation is above expectations, and unemployment is also higher than anybody would wish.
We've got 4% inflation at the present point in time and around 5% unemployment, although I think the real rate is higher than that, so is this a real problem? And what, anyway, was 1970s stagflation, which is what gave rise to this term? It's something we need to talk about because the truth is it's deeply misunderstood, and the chance of getting it back is very low indeed. But that requires us to understand the causes of the problems that gave rise to the end of Keynesianism in the 1970s.
Back then in the 1970s, and I was around at the time, inflation rose while unemployment stayed high. This wasn't what people expected. Under the Keynesian model, people expected those two to, broadly speaking, work in an inverse relationship. High inflation meant low unemployment. High unemployment meant low inflation. But people realised that you could have high inflation and high unemployment, and economists and politicians declared, as a result, that Keynesianism was dead, the model didn't work, and that they had to find something else.
The trouble was they ignored the fact that there were key global shocks that had given rise to the crisis, and inflation, and that the consequences were ones that would pass through the system in due course, as they always do.
There were two oil price shocks in the 1970s, one in 1973 and one in 1979; and they effectively quadrupled energy costs overnight - quite deliberately, as OPEC countries - Arab countries in the main - took action as a consequence of what Israel was doing with its attacks on Arab states, including Egypt in particular, but also on the West Bank.
The conflict there gave rise to this stress. As a consequence of the rise in oil prices, other global commodity prices also surged, and inflation was imported.
As a consequence of that import of inflation, which was unprecedented at the time, unions sought to protect real wages and went on strike to demand pay rises, and the government panicked. Now that use of union power was something that the unions had got used to because in the post-war period, unions had in fact done an extraordinary job of increasing the real wages of working people in the economy in the UK, and as a result, increased real living standards enormously. So the fact that they fought back against the reaction to rising prices by asking for pay rises was hardly surprising. But the government's panic reaction by tightening money supply, and trying to cut spending, and basically putting into place austerity measures, simply created a worsening situation that approximated to the onset of recession.
There was total policy confusion. It wasn't that Keynesian economics was failing. It was that politicians didn't understand the new world they were looking at.
And there was another factor in all this as well, and that was that they were dealing with the type of money they'd never seen before. In 1971, the world finally came off the gold standard. It was the USA that broke the relationship. And then we all broke our relationship with the dollar by letting the pound float. Now, we were getting towards that point as the 1970s progressed, but the fact was that the monetary system that had been put in place in 1945 had come to the end of its life because there was no underpinning in the reserve currency relationship between the dollar and gold. And there was no relationship left that could be relied upon between the pound and the dollar, and the opportunity to float wasn't something that politicians had understood.
But in practice, of course, when they did, pretty much everything went right with regard to currency. We just discovered a new level at which the pound could be traded, and the problem was over. But until politicians realised that they tried to maintain the value of the pound against imported inflation, which was being priced in this overvalued currency, with the consequence that working people were being punished. That is what caused the stagflation above all else, in my opinion, plus, of course, those external shocks, which they couldn't manage.
But in the middle of the confusion that was created by this, and the claim that Keynesianism was dead, monetarists like Milton Friedman seized the moment. They claimed inflation was always and everywhere a monetary phenomenon. They claimed that state spending was too high, there was too much government-created money in the economy, and that the government must be cut in size, and that the whole of the state should need to 'cut its cloth' to suit its current situation, and that the private sector should be allowed to pick up the slack and grow, and that was how the economy could be returned to prosperity. The mantra was simple: markets are good, governments are bad, and neoliberalism was born from that myth.
But the fact is that actually Keynes had never promised growth without limit. He'd always understood that inflation control was necessary to keep the management of the economy within the real constraints that it faced. He knew more than almost anybody on the planet that shocks like war or oil scarcity created situations that demanded state activity to deliver economic coordination. He had, after all, effectively planned the wartime economies of the UK in 1914 and 1939. He was the person who had literally underpinned the economic situations that had delivered the victory in two World Wars. So he wasn't blind to the risks that existed; he knew about them. But what he also knew was that it was fiscal policy and not blind monetarism that was the tool for stability, even though he did fully understand what monetary policy was, which is something that few people now appreciate.
The fact was, he knew that inflation wasn't just about money. What he knew was that it was also about power. And about the conflict between labour, capital and consumers over who bears the cost of scarcity.
He knew that because he had had to face that in 1941, when he realised that the scale of the conflict that the UK was involved in at that point of time required massive sacrifice by the wealthy in order to fund the war effort. And he solved that conflict at that time with very high tax charges and a reallocation of resources, and effectively enforced savings to make sure that the resources that were required to win the war were made available to that war effort.
So he understood this real relationship between money and resources. And in the 1970s, governments had forgotten about that process. They had effectively lived for 25 or more years from 1945 onwards in a world that was, well, unbelievably good for most people. Let's be clear, I was brought up in that era, and it was one of hope.
And then in the 1970s, when crisis came, governments had to decide between labour, capital and consumers. And under the influence of Friedman and Hayek, they sided with capital and not labour. But let's be clear, that was a political choice and not a Keynesian theory failure, and it broke the post-war consensus. The economics didn't fail. The politics that came in did, however, change everything, and in the end, as we know, for the worse.
Unions were weakened. Wages stagnated. Inequality soared. Real wages did in fact simply not rise for decades to come. Deregulation and privatisation claimed to be free markets when, in fact, they were anything but because they represented financialisation rather than the placement of savings into productive investment, which is what had happened beforehand. And today's crisis of low pay, asset bubbles, and rentier dominance all can be traced back to the point when Thatcher came into office and put Keynes behind her.
The trouble is that Rachel Reeves and Labour now echo those 1970s fears mouthed at the time by Labour Chancellor Dennis Healey and Labour Prime Minister Jim Callaghan, who said, "We must control inflation first." They mistook price pressure for fiscal irresponsibility when it wasn't. It was all about a demand for the government to control the allocation of resources, which they failed to do, and it was that failure which created the crisis.
And inflation now, just as then, is supply-driven, not wage-driven. In the 1970s, it was oil that drove price increases. In the 2020s, it has been oil, gas, fertiliser and wheat that have driven inflation. Those are the drivers now, pretty much the same drivers as they were in the 1970s. The trouble is, we are still repeating the monetarist errors because we believe that we could control this inflation by changing interest rates within our domestic economy, when doing so has absolutely no impact at all on what is driving the inflation in the first place. And pushing wages down in response to those external price changes is just going to make the economy worse.
Stagflation didn't disprove Keynes. It proved we misunderstood him. Keynes argued for full employment, public investment, and cooperation. When energy or supply shocks hit, he said the answer is planning and not austerity. And of course, he proved it during the wartime era. He said, "The state must invest to build resilience", and in the 1970s, it chose not to do so. Instead, neoliberal spin was created.
We now need to reclaim economic policy for people. We need to reject the call from markets that they must be given more, and people must be given less, because that's just absurd, because people with less haven't got money to spend in markets, and therefore, giving the markets more solves nothing because people without spending power literally cannot drive market growth. We have to stop blaming public spending for the excesses of private greed, which we see. And instead, we need a politics of care, a politics that delivers stability, and fairness and proper distribution of the benefits from the economy across everyone within it.
That way, we can truly build a legacy for Keynes, a legacy of justice that ensures that not only markets prosper - and I have no problem with that - but government prospers too, and as a consequence, people prosper on the basis of the security that governments can provide, letting them take the risk of engaging with the private sector.
It's that golden mean that we want to look for. It failed in the 70s because people did not understand what Keynes was saying. They did not understand how to deal with price shocks imported from external sources. And they didn't understand money and how to let it float on international exchanges, or how to use the power of the state to create money for social purpose, which we now do.
Get all those things right, and we don't need stagflation now. We don't need to face stagflation now. We could face prosperity now, but that requires people - politicians - with courage to accept that they have to make the decisions on how to allocate resources and resolve the conflicts between capital and labour and consumers, so that people get the resources they need to prosper, because that is what the role of government is - making sure that people prosper.
What do you think? Do you think the 1970s went wrong because Keynesianism failed? Do you think that neoliberalism was the answer to all known questions? Do you think that markets are still the solution to our problems? Do you think that the government should play a bigger role? Do you simply not know?
There's a poll down below. Let us know.
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To create a short variation, the increasingly popular Monetarism blamed Keynesian thinking for not fixing 70’s stagflation but Keynes never claimed to be able to fix everything, the essence of Keynes’ thinking was shit happens and sometimes all you can do is implement policies that minimise the damage. Politicians abandoned Keynesian thinking in favour of monetarist ideas and implemented policies that made things worse.
Agreed
I was a teenager at the time and remember the 1970s very fondly!
But seriously, this is absolutely spot on. Keynes did not “stop working” in the 1970s – its ideas were forged from the inflation of WW1 and depression that followed….. and proven in WW2 and afterwards as government (by and large) followed his policy prescriptions. Hardly benign conditions…. and it never pretended to allow politicians to dodge serious questions about allocating resources.
Let me get my flared jeans (with floral inserts) out again!
🙂
And you are right ab out the economics, as I hope the video makes clear.
There is a nice little write up which shows that the 1970s were not that bad. Also shows the point at which the commodity prices increased and the Govt. panicked
https://lordslibrary.parliament.uk/the-uk-economy-in-the-1970s/
There is this sentence:
“In January 1977, James Callaghan’s Labour government borrowed dollars from the IMF to support the pound. However, this loan was conditional on fiscal restraint and the reduction of public sector borrowing.”
Would this be the start of markets (in the form of the IMF) dictating to governments to reduce public spending?
Yes
I voted for monetarist mismanagement. It was the oil shock that caused inflation, but it was the monetarist reaction to it that caused unemployment. Exogenous causes, over which we had no (economic) control were behind oil price rises, but endogenous cause over which we did have control were the crucial ingredient to create the stagflation mix.
Monetarism was the catalyst that was added to a volatile situation to create a new phenomenon that was used for political purpose
I think much of the shift to neoliberalism happened with Gerald Ford. His economic advisor was Alan Greenspan. Nixon was the last US president who had a post war Keynesian economic policy. The anti inflation policy called “WIN” spectacularly failed. He also radically switched policies from saying tax increases reduce inflation to saying tax decreases reduce inflation. His administration had no idea what they were doing.
In 1971 the Heath govt passed the Competition and Credit Control Act. From what I recall it established ‘shadow banking’ of which I had a vague idea. It relaxed controls on banks. That seems forgotten today.
I bought a house for about £5,000 in 1970 and sold it for £10,800 in 1973 to move to Somerset.
Prices rose quickly and the press blamed greedy unions. Enoch Powell said it wasn’t their fault, they were responding to events. Looking back I think he might have been right. His other policies were to cut the role of Govt and published a book promising Income Tax at 4 s and 6d in the pound. It was then 8 shillings (40p)
The late 1970s media focused on inflation and accepted that ‘we can’t spend our way out of inflation’. Thatcher was elected with monetarist polices she barely understood. A policy also abandoned a few years later.
North sea oil was to save her IMO.
Neo-liberalism was pure opportunism. That is why up to that time it had been seen as rather strange and out of step with convention. It was the wrong change at the right time. At least we now see that anyway Neo-liberalism loves a good crisis – it was created out of crisis and creates crisis to perpetuate itself.
There were lots of other things cracking off – abuse of the legal system by giving corporations the identity as individuals worthy of rights; investor protection from company failure (used I think to induce company failure); use of the stock exchanges to aggressively monopolise markets and reduce competition and the coup de grace which was monetarism; the rise of North American style capitalism where investment is actually just a down payment on value extraction. And Japan and Germany who had been vanquished were now operating on a full head of steam whilst the U.S., the UK had grown complacent.
Seeing the profits of industrial cannibalism recorded as profit did not help politicians detect what was happening either. That is where the redistribution battle was lost and capitalism failed for me, right there.
But the other stuff – how the West backed Israel when it was the Muslims who had all the oil – seems to have been lost in time. And why was that? Was it anti–Semitic to back the creation of Israel or was it anti-Islamic? Its so messed up. We paid for it though, big time.
“industrial cannibalism” -great phrase Pilgrim
Wise politicians and economists build economies that are resilient.
In the modern world that requires that countries fully utilise and develop the talents of all the citizens in their jurisdiction. That would be an unprecedented first in the UK.
Progressive political parties could and must base their program on this core requirement.
And this is a fundamental reason why the idea of Universal basic Income, which has been a lunatic idee fixe in the Green Party (GPEW) must be dropped and almost certainly will be.
UBI would make British citizens passive vassals of neoliberalism where capitalism and oligarchic capitalists kept an unassailable grip on power. There would be no countervailing power exercised by trade unionists because there would be insufficient numbers of people in jobs.
But there is a viable alternative to this dystopian prospect. That is an economy that puts people rather than capital first and seeks to make its citizens as resilient and resourceful as possible.
It requires both economic and political empowerment. Neither of these can ever be perfectly achieved but each can be more fully realised than they have been in the UK to date. Doing so may also require the breakup of the UK into its nation states, including the unification of Ireland and with the constituent nations having their own currencies.
Governments must facilitate its citizens life-long learning and gear up to maximising employment. Under the Modern Monetary Theory dispensation which Zack Polanski has begun to articulate, even though it is not official Green Party policy – but may become so – the use of ongoing judicious deficit financing would become acceptable, not least because the electorate understood its rationale. That, together with a progressive tax system, allows a more expansive role for the state in rebuilding resilient Universal Public Services, each available, accessible and affordable, to meet the needs of the people and would include a state jobs guarantee.
There is a coherent and persuasive program for government based on these simple ideas that can be articulated in authentic engagement with the electorate. Zack Polanski is proving that it has traction with the electorate. But for it to succeed the Green Party needs to adopt a program of exclusively practical progressive policies, thoroughly understood by its activists, that it puts to the electors to persuade them to vote Green.
This is a work in progress that needs to be urgently expedited.
I agree with your explanation of what happened to the economy in the 1970s. While I am less familiar with how exactly the gold standard worked, or how the change to floating currencies worked in any real detail, I do accept that it played an important role, as did the mistaken measures taken by the Labour government to remedy the situation – seeking a loan from the IMF denominated in dollars.
I do think the role of energy is very important however. It was the coal industry where much of the most consequential actions took place, and no doubt the faltering supplies due to labour action, combined with the massive hike in oil costs undoubtedly impacted growth and inflation substantially. As you say, the oil price shock would pass through the system in time, as it does, but its legacy is as you describe – a significant contributor to the move away from Keynesianism.
Ironically the North Sea oil boom of the 1980s enabled Thatcher to guild the false economy created under neoliberalism from the very outset. Timing is everything. I suspect the experiment may have come to an end in 1983 without that oil revenue…
This is all a roundabout way of saying that the transition to a green energy model based on renewable power generation and electric vehicles is not just environmentally sound, but also has the potential to insulate us from future energy shocks and so reduce the potential for future inflation. While price inflation can be caused by a range of factors, I struggle to think of many times in history where energy has not been perhaps the biggest component. A self sufficient and renewable energy base (and with lower costs no less!) would do so much for us.
Just need to make sure we all oppose those nasty data centres which somehow the government loves, despite the fact they consume water and energy at absurd rates, with virtually no jobs attached. All for the profit of massive multinationals that pay little tax and shirk their responsibilities for the impact of social media…
And, of course, during the times of Keynes the currency went on and off the gold standard a number of times, especially during wartimes. There was no continuous gold standard in operation during the last century up until until 1971. That monetary fact is glossed over in many discussions of fiscal policies in operation from the time of WWI till 1971.
I recommend https://www.youtube.com/watch?v=cNvgEQ0RHs8&list=PLktPdpPFKHfre8XVEjdYxBNRlfIBzeYj as documenting much of what Richard says about when “the chaps” were in charge. And “Another economist and adviser to Margaret Thatcher, Alan Budd, worries that the whole Monetarist project might simply have been an attempt to reduce the economic and political power of the working class by raising unemployment and lowering wages, or as he puts it, “creating a reserve army of labour.” and making capitalists wealthier”
Thank you for this. It’s a question I’d thought of asking you, because the 1970’s are what are thrown back at you when you try to explain money to anyone. And I didn’t understand enough to have a response.
Thanks
“When Friedrich Hayek, patron saint of the Chicago School, returned from a visit to Chile in 1981, he was so impressed by Augusto Pinochet and the Chicago Boys that he sat down and wrote a letter to his friend Margaret Thatcher, prime minister of Britain. He urged her to use the South American country as a model for transforming Britain’s Keynesian economy. Thatcher and Pinochet would later become firm friends, with Thatcher famously visiting the aging general under house arrest in England as he faced charges of genocide, torture and terrorism.” — The Shock Doctrine: The Rise of Disaster Capitalism by Naomi Klein, https://amzn.eu/d/6MlIdTf
Video documentary: https://www.youtube.com/watch?v=aL3XGZ5rreE
I read The Shock Doctrine recently.
It’s a cautionary tale of what happens when governments give free rein to capitalists – they shaft ordinary people everywhere and lay waste to the planet.
“they shaft ordinary people everywhere”
To be clear, the following is due to neoliberalism (disaster capitalism), as quoted from The Shock Doctrine.
❌”according to Brazil’s later-established truth commission, killings by the state became routine”
❌”In just over a month, at least half a million and possibly as many as 1 million people were killed”
❌”The exact number of people who went through the Southern Cone’s torture machinery is impossible to calculate, but it is probably somewhere between 100,000 and 150,000, tens of thousands of them killed”
❌”The economic plan has had to be enforced, and in the Chilean context that could be done only by the killing of thousands”
❌”the wars in Chechnya have killed an estimated 100,000 civilians”
❌”The years of criminal capitalism have killed off 10 percent of our population.”
❌”By May 2007, more than 900 contractors had been reported killed”
YouTube algorithms pulled up your videos. I came to similar conclusions independently decades ago. You can find similar ideas scattered throughout my Witticisms & Aphorisms Blog at https://yaduck.blogspot.com It has a lot of other stuff, too.
I’ll share your videos in other capacities.
Thanks
Thanks again to your team for an insightful article.
Might it increase the transparency and positive use of inflation data if, instead one inflation figure, inflation information were differentiated into sub types?
Eg.
1) Internally and externally connected inflation
2) Internally connected inflation differentiated into direct goods and sevices, such as food, housing etc. and indirect services such as debt charges
Yes, in a word.
Hi.
Universal basic income – I keep reading how this would be a policy that capitalists would desire, yet it seems on the surface that it would be something the public would like. I mean who doesn’t want free money?
There must be more to it than this.
Ian Lovegrove says in a reply here that “UBI would make British citizens passive vassals of neoliberalism”.
There’s no glossary entry for UBI as far as I see.
I don’t understand it fully myself to be honest.
Is this a subject you could maybe do a video/blog on?
Thanks.
Ok…..
in the meantime you could try
Universal Basic Income is a neoliberal plot to make you poorer by Dmytri Kleiner
https://neweconomics.opendemocracy.net/universal-basic-income-is-a-neoliberal-plot-to-make-you-poorer/
Noted
A video is being drafted.
A question for any neoliberal enthusiasts you meet…
If GOV was “spending too much taxpayers’ money” in the 70’s having previously collected it from taxpayers at those “high” tax rates (40p in the £), where did the taxpayers get the money from to pay their 40p in the pound tax?
The Right Wing media mercilessly attacked organised labour . Putting all he blame on the responsibility for the crisis on working men and women who were struggling to put food on the table, They claimed the union barons were running the country. The Labour government didnt help. Jim Callaghan told then nation that it wasn’t the governments responsibility to provide full employment. He washed his hands of the post war consensus. The industrial action was grossly exaggerated by all the newspapers… Derek Jamieson ,the editor of the Daily Express wrote several in his book several years later: ” we pulled every trick in the book. We made it look like it was general ,universal and eternal. Whereas it was ,in reality ,scattered here and there. And no great problem “.
I agree with your interpretation.
Richard Werner argues that the central banks injected too much money into the economy (not enough removed) before the 1970s war and oil crisis stoking inflation :
“Many historical accounts suggest the decade of global inflation and recession that characterises the 1970s stemmed from this “oil shock”. But this narrative is misleading – and half a century later, in the midst of strikingly similar global conditions, needs revisiting.
In fact, inflation around the world had already been picking up well before the war (which lasted less than three weeks [started October 6 1973] ). The Federal Republic of Germany, Europe’s largest economy and biggest energy consumer, experienced its highest inflation rates of the decade throughout 1973 – first peaking at 7.8% in June that year, before the war and any hint of an oil price increase.”
more
https://braveneweurope.com/richard-werner-why-central-banks-are-too-powerful-and-have-created-our-inflation-crisis-by-the-banking-expert-who-pioneered-quantitative-easing
Hmmmmm…I am not wholly convinced. And Germany was not the UK.
One of your best!
Those that insist on the inferior economic measures have a hidden agenda of greed and an uncompassionate political philosophy. They seek to win the debate rather than finding the best answers. These ideologues would rather practice flat earth economics even if it leaves millions unemployed and impoverished and our vital goods and services in tatters – housing, health, infrastructure, education, research, defense,… through lack of investment.
Keynes and Schumpeter explained that it is not only our savings that funds investment, but also the increase in the supply of money. There is no need for land, labour and physical capital to be idle!
These ideologues refuse to examine historic precedent. Lincoln used the greenbacks to mobilize all his resources. In 1914 the UK did a terrific job of handling one of the great financial crises. https://www.youtube.com/watch?v=SIuNBQBD8CI &
https://www.lbma.org.uk/alchemist/issue-73/the-great-financial-crisis-of-1914
Yet the FED ignored those lessons in mishandling the Great Depression.
Pulitzer Prize winner Doris Goodwin summarized much of the Keynesian approach which created the economic miracle in Canada and America in WW2.
https://prospect.org/1992/10/01/way-won-america-s-economic-breakthrough-world-war-ii/ – and without paying interest on reserves!!!
All of those precedents were ignored.
I am certainly not an economist )although I did do a year of economics as part of my science degree at a time when Keynes was still being taught!), but I have never understood why anyone could possibly believe that externally induced inflation, such as high oil prices, can be controlled by interest rates. The only possible impact on inflation is in an upward direction, while at the same time putting downward pressure on domestic economic activity. Why are you the only economist who seems to understand this?
I am not alone.
We need to get heard. That is the problem.
You are not alone. Some fine economists have the same insights!! I particularly like Stiglitz, Keen, Hudson, Huber and Kumhof
Excellent point Cameron – about fighting Opec with interest rates. That battle was fought with investing in capacity elsewhere!