Is It 1978 All Over Again? Why Americans Are Right to Expect Much Higher Inflation

By Olivier Coibion and Yuriy Gorodnichenko

According to our latest survey of households, the average American currently expects inflation of more than 6% over the next year. Federal Reserve officials are predicting less than 3%. The average American is probably right. The reason lies in a historical pattern going back to the Great Inflation of the 1970s that is repeating itself with uncomfortable precision.

The 1970s inflation did not arrive in one continuous wave. As shown in Figure 1, it came in two. The first surge peaked around 1974 and then partially subsided — enough that policymakers and markets concluded the problem was behind them. It was not. A second and more severe surge followed the start of the Iranian Revolution in 1978, amplified by expectations that had never fully returned to normal. The Great Inflation was not the initial surge. It was the failure to prevent the second one.

Figure 1: Inflation in the 1970s and 2020s

We appear to be at the same juncture today. Inflation rose rapidly in 2021–2022, then declined over the subsequent years. When plotted alongside the 1970s experience (Figure 1), the parallel in the first phase is difficult to dismiss: a sharp increase followed by a partial reversal, with inflation settling above its pre-surge level rather than returning to it. Now we are being hit with a large energy shock due to the war in Iran, begging the question: is it 1978 all over again?

Unanchored expectations after the surge

The central lesson of the 1970s is that inflation becomes self-sustaining when expectations become unanchored — when higher expected inflation leads to higher wage demands and more aggressive price-setting, which in turn sustains higher realized inflation. Jerome Powell acknowledged this mechanism explicitly at Jackson Hole in 2022: “During the 1970s, as inflation climbed, the anticipation of high inflation became entrenched in the economic decision-making of households and businesses.” Figure 2 shows that this is precisely what has happened again: following the 2021–2022 surge, inflation expectations remained persistently higher than before — just as they did in the mid-1970s.

Figure 2: Inflation Expectations in the 1970s and 2020s

Why have expectations remained elevated? The inflation surge forced households and firms to pay attention to inflation and the Fed’s target for the first time in decades. What they learned was not reassuring: they observed a prolonged period during which inflation was well above target and concluded (correctly) that the central bank was failing in its inflation objective. Once that belief becomes embedded in wage bargaining and pricing decisions, it is self-fulfilling.

The energy price shock

Following the Iranian Revolution of 1978, oil production dropped precipitously, sending global energy prices sharply higher. Today’s war in Iran is doing something very similar: curtailing production across the Middle East, restricting transport through the Strait of Hormuz, and pushing global energy prices up. The OECD estimates that the resulting rise in energy prices will push U.S. inflation above 4% by year-end, as higher oil prices feed through to every product requiring transportation to distribute or produce. But the direct price effect is likely not the end of the story.

Figure 3 illustrates a less-discussed indirect channel that may be equally important: gasoline prices are one of the most powerful drivers of inflation expectations. The relationship is close and consistent across decades: when gas prices rise sharply, inflation expectations follow almost immediately, regardless of what is happening elsewhere in the economy. With expectations already elevated above pre-pandemic levels and sensitive to any visible price shock, a sustained rise in energy prices will not just raise inflation directly — it will push expectations higher still, prompting more aggressive wage demands and price-setting behavior across the economy. The Iran conflict therefore has two inflationary bites: one through the price of energy, and one through what it does to already-fragile expectations.

Figure 3: Inflation Expectations and the Price of Gasoline

The absent central bank

Whether this becomes a replay of the late 1970s depends on whether the Federal Reserve responds with sufficient urgency — and there is little reason to expect that it will.

When inflation surged in 2021 following supply constraints, the Fed argued that these types of shocks would not meaningfully affect inflation because expectations were “well-anchored.” As inflation and expectations kept surging, they ultimately recognized their error and acted to raise interest rates sharply but belatedly. The language now emanating from the FOMC is strikingly familiar — familiar not from the Volcker era that vanquished the Great Inflation, but from 2021. Faced with a new inflationary shock, policymakers are once again describing price increases as “one-time” changes in the price level rather than as inflationary pressures requiring a response. The FOMC’s March 2026 projections raised the inflation forecast from 2.4% to 2.7% — a relatively modest revision that signals limited concern compared to the OECD’s much bolder (and more realistic) update— while simultaneously flagging rising worries about the labor market. The implicit message is the same as in 2021: this is probably temporary, and the employment mandate takes precedence.

Compare this to how Paul Volcker framed the Fed’s commitment in November 1979, at the start of the disinflation: “the priority for policy was decisive action to deal with inflationary pressures and to defuse the dangerous expectational forces… the question I receive most frequently is not why did you do it, but rather, ‘Will the Fed stick with it?’ My own short and simple answer to that question is yes. I do not intend to qualify that answer.” That clarity of commitment was itself disinflationary — it directly shaped the expectations that were driving the inflation dynamic. The current Fed’s communications offer nothing comparable. When asked in September 2025 how the FOMC resolves tension between its two mandates, Chair Powell responded: “What we do is we ask, which is farther from — how far is each from the goal, and how long is it expected to get to the goal? So and then that’s — we think about those things, and we see…” Whatever one thinks of the underlying policy, the contrast in communicative resolve is stark.

What happens next?

There are real differences between now and 1979 — energy is a smaller share of production today, and the U.S. is a net exporter — which will dampen the direct inflationary impact of the Iran shock. But the expectational mechanism has not gone away, and the Fed’s current posture suggests it will not respond with the urgency the situation requires. The critical mistake of the 1970s was not the initial response to rising inflation — it was the premature conclusion that the problem had been solved. That mistake is being set up again. With every week that the Fed waits while inflation expectations rise, it is effectively accommodating the shock by allowing real interest rates to fall. Inaction in this environment is not a neutral stance — it is a dovish one. The question is not how households and firms could expect inflation of 4–5 percent over the next several years. Given what they have experienced, what they are observing in energy markets, and what they are hearing from the Fed, the more pointed question is: how could they expect anything else?