I’m not a big fan of the Federal Reserve’s current policy choices.
They obviously had to do something about the persistently high inflation, but I think they run the risk of doing too much. The magnitude of their interest rate hikes increases the risk of something going wrong in the financial system.
The Fed is in a tough spot because it acted too late, but also because it doesn’t want inflation to get so bad that it drives the hammer even harder in the future.
One of the main reasons the Fed is going so hard on it is that it doesn’t want a repeat of the 1970s where inflation remained consistently high for the entire decade.
Jerome Powell said the same thing to the House Financial Services Committee when he commented that the situation in the 1970s is “what we try not to replicate”.
Treasury Secretary Janet Yellen said something similar: “I came of age and studied economics in the 1970s and I remember what that terrible time was like. No one wants to see this happen again. »
From 1970 to 1981, the average inflation rate in the United States was nearly 8% per year. During this period, there have been four recessions, with the last recession delivering the deathblow to the inflationary beast.
I disagree with the idea that we are preparing a repeat of the 1970s, but there are similarities.
Both periods saw large government expenditures and an increase in the money supply. Both periods experienced food and energy shortages. And both periods were marked by rapid wage growth.
Wage growth is probably the thing that worries the Fed the most. After all, one person’s income is another person’s expenses.
If we compare the evolution of the average hourly wage to the total inflation by decade, you can see that there is a strong relationship between wages and prices:
Until the end of September, average wages have already increased by almost 17% during this decade. That’s almost as much as the entire 2010s in less than 3 years. The CPI is up just under 16% in the 2020s, so the relationship appears to hold.
So it’s not as if the Fed’s fears were completely unfounded.
However, there are also many differences.
The simplest reason, I believe, that we will not have a repeat of the inflationary spiral of the 1970s is because Fed officials studied that period and the mistakes made by their predecessors.
Much like the reason there was no Great Depression repeat of the 2008 crisis, it is because Fed officials had studied that period and the mistakes made by their predecessors.
Our knowledge of the 1970s and the scars they left will be one of the main reasons we won’t get a replay of this result.
In the 1960s, economists working for Presidents Kennedy and Johnson introduced an approach they called “fine tuning.” An economist who served on Johnson’s Council of Economic Advisers wrote, “Recessions are now seen as fundamentally avoidable, like plane crashes and unlike hurricanes.
This might explain why they underestimated the impact of Vietnam war spending and Great Society spending programs (Medicare, Medicaid, education, etc.) on the inflation rate, which went from less than 2% in 1960 to more than 6%. by the end of the decade.
Most policymakers and politicians were opposed to raising interest rates to a level that would slow inflation. President Johnson himself once said, “It’s hard for a boy from Texas to see high interest rates as a lesser evil than anything else.
When its Federal Reserve Chairman, William McChesney Martin, wanted to remove the punch bowl in 1965, Lyndon Johnson forcefully proclaimed, “Boys are dying in Vietnam, and Bill Martin doesn’t care!”
The message was received loud and clear. The Fed raised rates slightly, but then lowered them a few years later.
Arthur Burns led the Federal Reserve from 1970 to 1978, a period during which the rate of inflation averaged nearly 7% per year and reached 12.3%. Burns surmised there was little the Fed could do to slow inflation by raising rates since it could not control the actions of big business or unions.
So he persuaded Richard Nixon to implement wage and price controls in the early 1970s.
It did not work.
Nixon constantly pressured Burns to keep interest rates low despite ever-increasing inflation, and no one wanted to be blamed for causing a recession.
When Gerald Ford took office, he focused on inflation, but told Americans they should plant vegetable gardens, wear sweaters to save on energy costs and carpool to work didn’t do the trick.
When Jimmy Carter took office as president in 1976, he wanted to fight inflation through economic growth, saying, “My own belief is that the best way to control inflation is not to make money scarce.
Once he realized inflation wasn’t going away near the end of his first and only term, Carter basically told Americans they should stop buying so much stuff.
Good luck with that.
According to Robert Samuelson, the American money supply increased by 23% in the 1950s, 44% in the 1960s and 78% in the 1970s.
It wasn’t until Paul Volcker took over as Fed chair in 1979 that someone decided enough was enough. He quickly raised the federal funds rate from 10% to over 20%, causing two recessions in three years and pushing the unemployment rate into double digits.
In the 1960s, the Federal Reserve decided that jobs were more important than inflation. In the early 1980s, Volcker decided that controlling inflation was more important than employment.
Interestingly enough, the current Fed regime went through a similar cycle, except it happened in two years, not 20 years.
Following the pandemic, Jerome Powell and his company decided that getting back to work was their number one priority. And it worked :
Now the Fed has shifted its focus from the labor market to inflation. It hasn’t worked yet, but these things tend to work with lag.
Just look at how quickly money supply growth collapsed following the huge spike in pandemic-induced spending:
It took a while for this initial increase in money supply to turn into inflation, so it will likely take a while for the reversal to occur as well.
Although we have seen oil prices rise in recent years, this is a far cry from the change people faced in the 1970s:
Oil prices rose from around $2 a barrel in the early 1970s to $34 a barrel in 1981. This represents a 17-fold increase in prices.1 Oil was around $60 a barrel in the 2020s. To match the rise in the 1970s, it would have to exceed $1,000 a barrel.
I guess anything is possible, but that seems unreasonable. In the 1970s you had the end of Bretton Woods where Nixon suspended the convertibility of dollars to gold. There was the oil price embargo in 1973 and the Iranian revolution in 1979.
Today we have the war in Ukraine, but we also have OPEC and the American shale industry. There are no queues at the gas station like in the 70s.
Energy was also a much larger share of household budgets in the 1970s than it is today:
There are also other long-term structural forces at play here that make it unlikely that we will see a repeat of the inflation of the 1970s.
Technology is a deflationary force and this sector represents a much larger slice of the economic pie today than it did back then.
A lot of people are worried about globalization following all the supply chain issues caused by the pandemic, but it’s not like we’re going back to the 70s.
Additionally, you have an aging demographic in the developed world.
Yes, the largest demographic group in the United States – millennials – are in their early years of household formation, just like baby boomers were in the 1970s.
But when the first wave of baby boomers entered their working and spending years, there was no other generation to offset those expenses. Baby boomers have eclipsed all other demographic groups.
We have never had such a large aging demographic as baby boomers. This should help offset millennials reaching their peak drinking years. There is a countervailing force for millennials that didn’t exist in the 1970s for baby boomers.
Inflation could obviously remain stubbornly high in the short to medium term, but I don’t see a repeat of the 1970s in the 2020s.
The Fed is already so much further ahead on this issue than it was then.
We have learned the lesson of this terrible period of stagflation.
And there are long-term trends in place that should contain long-term inflation.
Further reading:
What would you do if you ran the Fed right now?
1I’m not usually a log scale chart type, but this clearly shows the massive relative movement of oil prices in the 1970s.
#todays #inflation #repeat #1970s
