Lessons from history on inflation and political risk
The great inflation debate in the U.S. is still in its early stages, but the most recent inflation print, showing May’s consumer prices rising at their fastest rate since 2008, brings to mind a bit of history.
Once upon a time, inflation galloped ahead at double-digit rates, driving up the prices of food, fuel, housing, and more. Prices rose so fast people organized protests and boycotts, refusing to buy items like meat because the price was just too high.
The Wall Street Journal reminds us of those times. Some of it sounds eerily close to what’s happening today:
President Johnson and then President Nixon badgered the Fed to keep pumping money into the economy and pushing interest rates lower, thinking it would drive unemployment down and help their economic programs and electoral prospects. The Fed often complied, but the main effect was to drive prices higher.
The politically-motivated policy decisions piled up. The result was predictably horrible:
Unrelenting inflation sent the U.S. economy into a game of leapfrog. Workers demanded pay increases to keep up with the rising cost of living. Many of them got raises through cost of living adjustments in union contracts. To keep up with rising costs, in turn, businesses raised prices even more. Thus grew a relatively new concept in the economic lexicon, the “wage-price spiral.”
Economic relationships fell out of their old patterns. Some economists had thought that when unemployment rose, inflation would fall. Instead, both went up, giving rise to yet another new term, “stagflation.”
So we’re doomed to repeat the past, right? Maybe not:
The dollar floats freely and isn’t fixed to the cost of gold. That diminishes the risk of an abrupt collapse in its value with international repercussions. Adjustments happen tick by tick on traders’ computer screens almost every minute of every day.
Rising global competition has left today’s workers with less bargaining power, making it harder for them to demand wage increases in response to inflation. In 1976, six million unionized workers had automatic cost of living adjustments in their contracts. By 1995, the number had dropped to 1.2 million, and such agreements are now rare. Workers thus bear the brunt of inflation, but wage-price spirals seem less threatening.
In recent years, the memory of inflation in the 1970s has worried American policy makers less than the specter of Japan’s slow growth and low inflation in the 2000s. Inflation has run below the Fed’s 2% target consistently since 2008-09, prompting Fed officials to conclude that what the economy really needed was stimulus. Stagnation has been their focus, not stagflation, which is why they have worked so assiduously to keep interest rates low.
The conventional wisdom that current price jumps are passing blips assumes a great deal – about the data, what it measures, and how quickly governments can respond. But most of all, it assumes a select group of bankers and economists can anticipate inflation, and act accordingly.
Central bankers are many things, but they can’t tell the future. What they can, and must, do is learn from the past.