Final answer:
In the 1970s, economists faced the new challenges of stagflation and a slower rate of productivity growth, both of which went against traditional economic beliefs. Stagflation involved the unprecedented occurrence of high inflation alongside high unemployment. The productivity growth slowdown resulted in a labor market imbalance where wages continued to rise despite an absence of corresponding increases in productivity.
Step-by-step explanation:
During the 1970s economy, economists were confronted with two phenomena that they had not believed possible: stagflation and a significant decoupling of productivity growth from wage increases. Stagflation, a portmanteau of stagnation and inflation, was marked by the unusual combination of high unemployment and high inflation, which contradicted the traditional economic belief that these two factors moved in opposite directions. Concurrently, the U.S. experienced a period of substantially slowed productivity growth, which went against the pattern of consistent gains prevalent in earlier decades.
Productivity growth slowed dramatically from an annual rate of 3.3% from 1960 to 1973 to just 0.8% from 1973 to 1982. Wages continued to rise due to previous expectations of productivity growth, creating a labor market where the wage level did not match the demand for labor, thereby increasing the natural rate of unemployment. This mismatch was a result of the demand for labor no longer shifting upwards, even as wages did, due to the unexpected decrease in productivity.
The concept of stagflation was further brought to light by supply shocks, such as the mid-1970s oil crisis, as well as changes in people's expectations about inflation. These factors resulted in a shift in the Phillips curve, which describes the inverse relationship between the rates of unemployment and inflation, demonstrating that the trade-off between inflation and unemployment could vanish under certain conditions.