The 1970s Stagflation Crisis and the Neoliberal Shift

The 1970s stagflationary crisis was prompted by high federal spending for the Vietnam War, global supply shocks — namely, the Organization of the Petroleum Exporting Countries (OPEC) oil embargo — and most importantly a conscious decision to pursue an expansionary monetary and fiscal policy regime. That is, the government increased spending, cut taxes, and kept interest rates low during this postwar “golden age.” This stimulated demand and sustained growth even as inflation rose. In the years leading up to the crisis, policymakers deprioritized price increases to preserve a fragile class compromise between labor and capital. In exchange for political restraint, workers were promised full employment and wage growth. This arrangement was essential to the legitimacy of American capitalism during the Cold War. But by the late 1970s, rising inflation, intensifying worker demands, and fiscal strain made this compromise untenable.

During the “golden age,” the Phillips curve went largely unchallenged. But when the stagflation crisis hit, Keynesians struggled to explain the economic trap that they had previously argued was impossible. While some attempted to adapt their model or downplay the severity, it was largely discredited in the moment (though contemporary models, such as those of New Keynesians or conflict theorists of inflation build on the Phillips curve).

In contrast, the monetarists, a group of economists who believed the supply of money determined prices, were ready to offer a more decisive narrative. Milton Friedman, the most famous member of this group, argued that the problem was “too much money chasing after too few goods.” Under the influence of these ideas, Fed chairman Paul Volcker raised interest rates dramatically in what became known as the “Volcker Shock.” After October 1979, interest rates reached, in the words of then German chancellor Helmut Kohl, their “highest level since the time of Jesus Christ.”

The thinking was that raising the cost of borrowing money would slow spending and investment, in turn alleviating price pressures. The economy responded very slowly to this move: Volcker’s maneuver took two tries and nearly a decade to have its intended effect. In the meantime, the United States went through two relatively brief but acute recessions in the late 1980s. Unemployment peaked at 10.8 percent. Manufacturing and construction were hit hardest and unions faced significant declines in membership.

The government responded to these recessions not by reversing course, but by doubling down on monetary tightening and pro-market reforms. The Reagan administration championed deregulation, tax cuts for the wealthy, union busting, and welfare retrenchment. The crisis transformed the balance of power between classes and helped secure political support for a previously unimaginable economic order.

In retrospect, it is clear that the stagflationary crisis of the 1970s was a key turning point in US class relations: the hegemony of the neoliberal regime, the dismantling of the welfare state and union power, and the increased reliance of the economy on financialization rather than productive investment were all trends solidified during this tumultuous period. As the historian Giovanni Arrighi presciently observed in 1994, financialization followed its usual pattern of intermediating and benefiting from hegemonic transitions.

Orthodox Thinking Today: A Cautious Fed

Today some economists argue that, with far less painful interventions, inflation would likely have declined on a similar timeline. Poor policy decisions exacerbated the crisis rather than counteracting it. One frequently mentioned example is the repeal of Regulation Q, which capped the interest rates that banks could offer on deposits. As inflation rose, households demanded better returns on their savings. In 1980, Congress began to repeal the measure and interest returns on deposits soared quickly to match inflation.

This encouraged households to save more and spend less, reducing inflationary pressure. The reform also restored the Fed’s ability to transmit monetary policy: as deposit rates started to track the federal funds rate, interest rates could actually influence the economy. Thus, some believe that the recovery was more about fixing financial transmission than raising rates.

Despite these clear failings, present economic leadership still views the Volcker Shock as painful but necessary, lauding the former Fed chairman’s decisiveness for restoring market confidence. Or in the words of former Fed vice chair Alan Blinder, “Volcker re-taught the world . . . that tight monetary policy can bring inflation down at substantial, but not devastating, cost.” They would suggest a highly similar policy response today, albeit with minor adjustments in implementation.

This means prioritizing inflation containment through interest rate hikes. But unlike the 1970s, today’s approach is more gradualist, favoring cautious adjustments and a higher tolerance for short-term deviations from “optimal” inflation and employment targets. For example, Mohamed El-Erian, the former CEO of PIMCO, says the Fed should not act prematurely, but “should give priority to putting the inflation genie back in the bottle,” while former New York Fed chair Bill Dudley said stagflation is now the “best case scenario” for the US economy under Donald Trump, perhaps “making interest rate hikes necessary.”

Outside of monetary responses, many progressive-leaning economists support fiscal policies that require high-government spending to address inequality and stagnating growth, but only if interest rates remain low. Hinging their support of more redistributive macroeconomic policy, such as climate programs or progressive taxation on the governing monetary policy framework makes these policies an occasional exception rather than a recurring tool. This reinforces the Fed’s outsize role in economic management.

This June, the Fed voted unanimously to maintain interest rates at 4.25-4.5 percent, but Powell raised his inflation forecast and said that he was prepared to tighten if stagflationary threats persisted. Many economists predict they will likely hold rates until the fall, and until then will rely on “forward guidance” to keep inflation anchored. That is, sharing expectations of the future to talk the public down from acting “irrationally.”

Ben Bernanke, former Fed chair, once said that monetary policy was “98 percent talk, 2 percent action.” While regular communications and transparency can help modulate panic, there are meaningful anti-labor implications to this approach.

As the cost of living rises, workers naturally demand higher wages. In response, the Fed assumes that employers will raise prices to preserve profit margins, causing a snowballing inflationary spiral. When the Fed signals through press statements that it will quickly counteract wage-driven inflation, it’s tacitly warning employers, investors, unions, and the public alike that it will meet wage growth with contractionary policy.

This creates a politics in which policymakers and the public come to blame inflation on the growing labor-share of income, rather than corporate pricing decisions or supply-side shocks. But in reality, the battle over inflation is a class struggle between employers and workers over the distribution of economic surplus and who will bear the costs.

The idea that in the late 1970s flattening the Phillips curve and returning to low inflation was done on the back of the American working class is not a fringe socialist view. Fed economist David Ratner’s work has shown that the disinflation of the 1980s was only possible through a decades-long attack on organized labor’s bargaining power and wage share.

Today the government continues to use sanitized and technocratic language to undermine labor’s attempts to maintain a living wage in the context of inflation, portraying the relative resurgence of organized labor taking place since COVID-19 not as social progress but as a threat to macroeconomic stability — or, in the World Bank’s terms, as “structural economic rigidities” to be overcome. Meanwhile, recent coverage only briefly acknowledges the potential devastation a stagflationary crisis poses to ordinary Americans. Mainstream news outlets advise them to “budget for emergencies” and “pay down high-interest credit card debt” in ways that are patronizingly divorced from the realities of poverty and inequality.

A Socialist Response

Socialist theory provides an alternative framework to thinking about today’s stagflation, one which goes deeper than a naive nostalgia for the pre-Trump economy. In the second volume of Capital, Karl Marx argues that capitalist functioning requires workers and capitalists alike to consume the goods they produce, and capitalists to reinvest the extra portion (or surplus) into productive capacity. But this ideal account of markets presupposes a relative equilibrium between the value of commodities produced and aggregate market demand.

In her 1913 book, The Accumulation of Capital, the Marxist economist Rosa Luxemburg was the first to point us to a contradiction in this model: worker’s wages are suppressed to preserve profits and capitalists reinvest a much larger share of their income than they consume on goods. Luxemburg argues that because of this dynamic, capitalist systems face chronically insufficient demand for goods and a constant crisis of overproduction — too much capital chasing too few profitable investment opportunities, an unlikely precursor to the thinking of Milton Friedman.

Since capital is on a desperate and perpetual “hunt for yield,” it directs money into nonproductive outlets — e.g., stocks, bonds, and financial derivatives. This fictitious circulation of money does not generate material goods or services (unlike, say, investments in infrastructure or labor training). Instead, it enriches asset holders without expanding value in the real economy, deepening inequality and economic fragility.

Volcker’s intervention was a perverse response to this structural issue. By increasing the returns for holders of money and debt, his regime ushered in an era of financialization — moving capital from productive industry to asset markets dependent on future surplus claims. As the sociologist Greta Krippner writes in her book Capitalizing on Crisis: The Political Origins of the Rise of Finance, this shift was not a spontaneous outcome but one actively orchestrated by state actors hoping to resolve social crises without redistributive concessions — delegating economic management to financial markets and deepening capital’s movement in speculative circuits.

From this perspective, stagflation originates in a contradiction between financial claims and the stagnation of value production. These contradictions can be accelerated, but crucially not caused, by supply-side shocks or poor economic policy such as Trump’s tariff regime or large spending paired with tax cuts such as the Big Beautiful Bill.

While a particularly salient manifestation of capitalism’s contradictions, stagflation is a visible and natural consequence of long-term imbalances. There are more ambitious responses to the crisis than interest rate adjustments. We can demand the government impose stronger credit regulations on financial institutions, such as issuing controls on the type and amount of credit banks can issue, to steer the economy toward socially productive investment. Relatedly, macroprudential regulation — such as capital requirements or limits on risky lending — can prevent speculative bubbles and shift risk away from workers.

We can also promote expansionary fiscal policies that reverse decades of upward distribution and enable household consumption. This could include direct cash transfers, social safety net protections, debt jubilees, and wealth taxes to reclaim excess gains captured by rentiers. Instead of tolerating exploding price spirals, governments can also impose “tailored price controls on carefully selected prices,” such as Kamala Harris’s campaign proposal to control food prices.

A political economy that treats unemployment, depressed wages, and the unaffordability of necessary goods as unavoidable is one which makes the political choice to prioritize capital machinations over justice and material safety. Both those committed to a functional market economy and those hoping to transcend our current economic order for a socialist horizon have a stake in responding to stagflationary threats and the broader upheaval caused by Trump’s economic regime.