The latest inflation figures should not be ignored
The sharp rise in consumer prices this spring may be a factor, but it can also be a sign that inflation is returning as a chronic problem. For those of us who can clearly remember the 1970s economy, this is a terrifying prospect. Everyone else would benefit from reading the latest coverage.
Recent events challenge the statements of leading modern currency theorists who thought the US could maintain much larger deficits without triggering major increases in the cost of living. Instead, the traditional rules of public finance still seem to apply: the deficit spending financed by the Federal Reserve’s money creation is inflationary.
Analogies between the current situation and the 1970s are not entirely effective. In the early 1970s, inflation was in full swing. Instead, we should learn lessons from 1965, when price inflation began to rise. Before that year, inflation appeared to be under control, with CPI growing 1.1-1.5 percent annually between 1960 and 1964 – similar to previous years.
As in 2021, an ambitious unified democratic government was introduced in the 1965 post-election year. That year, Congress passed Medicare and Medicaid, began providing federal aid to local school districts, and expanded federal housing programs significantly. At the same time, the Johnson administration expanded its US involvement in Vietnam and increased the defense budget. The federal budget deficit rose from $ 1.6 billion in fiscal 1965 (which ended June 30) to $ 27.7 billion, or 3% of GDP, in fiscal 1968.
Although the Federal Reserve made some attempts to stave off inflation, it generally conformed to government fiscal policies, as published by Allan Meltzer of the St. Louis Fed in the full history of that period. Between the calendar years 1965 and 1969, annual CPI growth rose from 1.6 percent to 5.5 percent, setting the stage for the Nixon administration to close the gold window of the US Treasury and to introduce wage and price controls. Inflation reached double digits in 1974 and again between 1979 and 1981. Notably, these were also years of recession that refuted the fallacy of the Phillips curve, which was an alleged political compromise between inflation and unemployment. In the early 1980s, we had ample evidence that ill-considered policies could bring us a combination of high inflation and unemployment, known at the time as “stagflation”.
This policy mix was not good for equity investors either. The Dow Jones Industrial Average moved sideways during the inflation period, closing at the same level in December 1982 as it was in January 1966. One lesson from that period was that high interest rates can be bad for stocks.
This could be one reason the Fed is reluctant to allow rate hikes today. Although announcements from the recent meeting of the Federal Reserve’s Open Market Committee showed greater willingness to normalize interest rates, no action is expected before 2023.
Interest rate hikes could cause further concern for the Fed in today’s environment. With the volume of adjustable rate mortgages and corporate loans in the United States today, an increase in interest rates could drive heavily indebted homeowners and businesses into bankruptcy and potentially trigger a recession. The federal government would need to extend its record holdings of short-term debt at higher interest rates, increase its interest spending, and possibly crowd out more popular spending priorities.
But if private capital is to continue to participate in debt capital markets, for example for corporate bonds and bank loans, interest rates will have to rise to compensate for the loss of purchasing power of their capital.
Although CPI annual growth declined sharply after 1982, it is not entirely true to say that inflation has been defeated. Except for a few years around the turn of the century, the federal government continued to show deficits, some of which were monetized. In particular, the government began running trillions in deficits and the Fed cut interest rates to near zero during the Great Recession, but consumer price index growth remained subdued.
But CPI doesn’t tell the full story. Some economic sectors have experienced significant inflation, but they are not fully included in the consumer price index. Home prices, healthcare costs, and tuition fees have skyrocketed over the past few decades. Meanwhile, globalization and improved technology have kept apparel and consumer electronics affordable.
In the 1970s, most of the world was not part of the global economy. Eastern Europe was part of the Soviet bloc, while China, Vietnam, and India had not yet become major exporters. As more and more low-cost sellers of goods and services came online in the 1980s and 1990s, prices were pushed down (often, and unfortunately, at the expense of American manufacturing jobs). The trend of developing countries to join the international trading system and produce inexpensive consumer goods is over. In fact, the recent surge in protectionism is more of a brake on the wave of international price competition.
On the other hand, technological improvements in certain sectors could continue to protect us from inflation. For example, the crowding out of human cashiers through automated checkouts could curb price increases at large retailers, supermarkets, fast food chains, and other establishments that can afford to invest in them. Smaller businesses faced with higher wages may have to try to pass them on to consumers in the form of higher prices. In some parts of the country, restaurants are already trying to cover costs without increasing the prices on their menus by adding various surcharges that appear to be linked to specific costs.
It is possible that inflation is now shifting from asset and human-intensive services to consumer goods, but it will take us several months of additional data to know for sure. In the meantime, policymakers should be careful about adding public debt and the money supply.
Marc Joffe is a policy analyst at Reason Foundation, a former senior director at Moody’s Analytics and the author of the study.Unfinished business: Despite Dodd-Frank, rating agencies remain the weakest link in the financial system. “