The Keynesian Collapse

For decades following the Second World War, economic policy rested on a comforting mechanical certainty. The prevailing neoclassical synthesis relied on the Phillips curve to map out a tidy inverse relationship between inflation and unemployment. It suggested that governments faced a straightforward dashboard dial: if you wanted lower joblessness, you simply had to tolerate a predictable tick upward in consumer prices. The economic machine had trade-offs, but they were stable ones.

Then the oil shocks of the 1970s arrived, and the machine broke.

Prices soared while unemployment refused to fall, producing the cursed pairing of stagflation. This simultaneous surge of inflation and joblessness flatly contradicted the Phillips curve, rendering its central trade-off useless. When a model tells you that a certain condition is mathematically and historically barred from happening, and then it happens anyway, the model tends to lose its authority.

The collapse of the consensus triggered a monetarist counter-revolution and the rapid rise of new classical economics, as theorists rushed to rebuild macroeconomics on firmer foundations. The crisis exposed a hidden vulnerability in the old models: the Phillips curve was not a universal law of nature. It could shift violently, hijacked by sudden supply shocks and the shifting expectations of a public learning to anticipate future inflation.

Whether that collapse stemmed from inherent flaws in Keynesian theory or simply from the sheer, unpredictable brutality of the decade's supply shocks remains a point of quiet debate. But economic orthodoxy rarely stays buried for long. While the near-consensus status of post-war Keynesianism was permanently shattered, the discipline eventually drifted back, spawning a new Keynesian approach that quietly re-emerged as the preferred framework for many modern economists.