14.6 – Price Cyclicality, WW II to 1983
Learning Objectives
By the end of this section, you will be able to
- Explain, using heterodox economic theory, the underlying causes for countercyclical prices prior to the 1980s
In chapter “Inflation“, you learned that the American economy saw a period of significant inflation starting in the late 1960s and ending in the 1980s, and this was followed by a period of relatively low inflation (although the pandemic appears to have brought an end to that). You also learned that prices, generally, ran countercyclically prior to around 1983–that is, moving up (or up faster than before) in recessions and down (or up slower) in expansions–, but then became acyclical afterwards–which is to say that price movements appeared to become uncoupled from the business cycle. In these final two sections of the present chapter, we’ll highlight some important reasons for why prices behaved the way they did in these two periods.
Our explanations will draw from heterodox economic theory, but first it is worth considering the orthodox approach, using aggregate supply and demand to explain changes in the overall price level. Now, the nice thing about a supply and demand model, aggregate or otherwise, is that it can explain the cause of a change in price and quantity simply by reasoning backward from the observed changes in price and quantity themselves. If, for instance, prices went up then this must be due to either an increase in demand or a decrease in supply–it simply becomes a question of whether quantity (in the macroeconomic sense, GDP) was rising or falling at the time. The rising inflation of the late 1960s, for instance, when the economy was still expanding, could be explained by an increase in demand stemming from the spending the U.S. government was doing to prosecute the Vietnam War. The argument in this case is that high levels of output cost more to produce per each additional unit and hence will only be produced when there is enough spending to pay for higher prices. In contrast, the inflation of the mid-1970s, during a period of stagnation, could be attributed to the supply shock of increasing oil prices.
But the historical record pokes holes in this approach. For instance, the countercyclicality of prices over the period between World War II and the early 1980s–that is, prices moving in the opposite direction as quantities– suggests that shifts in aggregate supply, not demand, were effectively driving the business cycle. But is this really plausible? And if so, why then did prices stabilize afterwards? Were there no more supply shocks? Not from the rapid globalization or the advent of the internet that took place in this period? To be sure, orthodox economists continue to debate these questions and to proffer a variety of answers that, in essence, revolve around what they think happened to aggregate supply and aggregate demand. Below, however, we’ll look at the alternative, heterodox explanations.
Understanding