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One of the most widely cited reasons for the '70s stagflation was expansionary monetary policy employed by the central bank.

Below is M1 during this time period (source), and it does not look like there was an unusual growth at the time.

enter image description here

How was it possible for inflation to be so high when the money supply was growing at the normal pace?

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    $\begingroup$ @Questor, that is mostly because of a different definition of M1, see here and nothing depressing at all. $\endgroup$
    – AKdemy
    Commented May 1 at 3:42
  • $\begingroup$ @AKdemy didn't know about that... Good to know thank you. $\endgroup$
    – Questor
    Commented May 1 at 15:01

2 Answers 2

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  1. Inflation does not necessarily depend on M1 but broader monetary aggregates. Standard monetary aggregate in inflation research is M2, M1 is rarely used and it is irrelevant here because it does not represent most money in the economy.

    Fred data M2 show that during the period 1970-1980 M2 grew by 64% just in that decade.

  2. What matters for inflation is not just how money supply grows but how it grows in proportion to other variables.

    In standard textbook macro models money market equilibrium is given by; $P = \frac{M}{L_m(Y,i)}$

    where P is the price level M money supply, and $L_m$ money demand that depends on real output and interest rates.

    If money supply grows at 10% but other variables like output and thus also money demand is stable then you would expect to see 10% inflation.

    If money supply grows at 60% but money demand grows at 70% then there will be 10% deflation.

    During stagflation period there was minimal output growth and as a result any small change in money supply would be predicted to result in inflation using standard textbook economic models.

    There are other things in more advanced models that can contribute to inflation, such as unanchored inflation expectations, but even using econ 101 model inflation in that period is not something that would be surprising.

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I think we are looking at 2 different charts.

1960-1970 the money supply went from 140 billion to 200 billion. A 42% increase.

1970 to 1980 the money supply went from 200 billion to 385 billion. A 92% increase.

From increasing by 4.2% year over year to increasing the money supply by 9.2% year over...

I don't know about you but that looks like the rate of increase more than doubled during the 70s from what it was in the 60s.

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