The 1970s Oil Shocks and the Great Inflation

Twice in the 1970s, oil supply was disrupted by geopolitics and prices spiked in response. In 1973, Arab oil-exporting countries embargoed the U.S. and other nations that supported Israel in the Yom Kippur War, and oil roughly quadrupled in price within months. In 1979, the Iranian Revolution disrupted Iranian oil production and prices roughly doubled again. Each shock meant every business that used energy — which is nearly all of them — faced a sudden, large increase in input costs, all at once.

An oil shock like this isn't just a one-time price increase; it's dangerous specifically because it can start a wage-price spiral. Higher energy costs push up prices across the economy. Workers, seeing their real wages fall behind rising prices, demand and often win higher wages to compensate. Those higher wages become a cost businesses pass on as still-higher prices. If nothing interrupts this loop, inflation can keep ratcheting upward even after the original oil shock has passed, because the expectation of rising prices has become embedded in how everyone sets wages and prices going forward.

That is close to what happened in the U.S. through the 1970s. Inflation, which had been low through most of the 1960s, climbed above 12% at points and stayed persistently high for most of the decade. Making it worse, unemployment was also elevated for much of this period — a combination called stagflation that the dominant economic thinking of the time considered close to impossible, since inflation and unemployment were assumed to trade off against each other, not rise together.

Part of why the spiral went on so long was policy hesitation. The Fed under Arthur Burns repeatedly eased policy at signs of economic weakness, worried about triggering a recession, which let inflation expectations become entrenched rather than snuffed out early. It took a decisively different approach — Paul Volcker's much more aggressive rate hikes starting in 1979 — to finally break the cycle, at the cost of a severe recession.

The 1970s remain the standard historical reference point whenever a modern supply shock (a pandemic, a war, a tariff round) raises the question of whether inflation expectations might become unanchored the same way — the lesson quants and central bankers alike draw from the decade is that credible, early, and sustained tightening is what prevents a temporary shock from becoming a permanent one.