In addition, in
1974, President Gerald Ford responded to the crisis with a Whip
Inflation Now campaign that included Keynesian calls for contractionary
fiscal policy in the form of fiscal restraint and a tax surcharge.
The result of these discretionary policies was to drive the economy
deeper into recession even as oil price shocks in particular helped drive
the inflation rate ever higher.
Then, in 1975, alarmed by the
deepening recession, the nation's policymakers switched their
Keynesian strategy as they replaced inflation with
recession as their number one policy worry.
As Congress passed a $23 billion Keynesian tax cut to fight
recession, the Federal Reserve switched to an expansionary Keynesian monetary policy.
Result was a disaster.
It drives home the seemingly unreconcilable
dilemma that stagflation poses for traditional Keynesianism.
High inflation remained, even as the economy failed to recover from recession.
It was this inability of the Keynesian economics to cope with stagflation that
set the stage first for professor Milton
Friedman's monetarist challenge to what had become
the Keynesian orthodoxy and then later for the emergence of supply-side economics.
To better understand the failure of Keynesian
activism in a world of stagflation, we have
to delve more deeply now into modern inflation
theory and the mysteries of the Phillips Curve.