Oil Shocks and Stagflation

The End of Cheap Energy

The oil shock of 1973 ended the postwar Golden Age. When OPEC embargoed oil, the price quadrupled from 3 to 12 dollars a barrel, followed by a 1979 shock above 35 dollars.

Stagflation is the simultaneous occurrence of economic stagnation and rising inflation. It broke the Phillips curve, which assumed an inverse trade-off between unemployment and inflation.

$$\text{Demand shock: } \Delta \text{ inflation and } \Delta \text{ unemployment move oppositely}$$ $$\text{Supply shock: } \Delta \text{ they move together}$$

As a supply-side shock, higher oil costs pushed prices up while reducing output, defeating standard Keynesian demand tools. Stimulating demand during an oil shortage buys more inflation, not output.

Breaking Stagflation

Paul Volcker at the Fed in 1979 chose to crush inflation via extreme monetary tightening, raising interest rates above 20%. The cost was a severe 1981-82 recession, but inflation fell from 13% down to 3% and expectations anchored.

This sparked a broader 1980s policy rethink toward deregulation, privatization, and independent central banks focused strictly on price stability.

The structural legacy: energy intensity—energy per unit of GDP—began a permanent decline as economies diversified into services and fuel efficiency.