The headline, “I Remember 1970s Inflation. Politicians Should, Too,” caught my eye recently. More and more people today seem obsessed with the economic upheaval of the 1970s and are using the fear of repeating that episode as a guide for fighting today’s inflation.
It turns out that policymakers in the 1970s were doing something similar. They still remembered the massive unemployment of the Great Depression. Their fear of repeating that economic collapse led them to enact policies that they thought would prevent another depression but that led to higher inflation.
Fighting the last war ended badly in the 1970s and it will end badly today. We need to understand what happened in the 1970s and avoid applying the wrong historical analogy as we deal with higher inflation rates today.
The 1970s
Inflation started increasing in the late 1960s, rising from 1-2% to 3%, which didn’t set off any alarm bells. As the inflation rate continued to creep up, policymakers of the time decided to tolerate it as the price for avoiding another Great Depression and the job losses they so feared.
This economic analysis was based on the concept of the Phillips Curve, which posited that there was a stable relationship between inflation and unemployment. Specifically, lower rates of unemployment drove up inflation rates, so the price of reducing unemployment was living with higher inflation.
However, as the 1960s turned into the 1970s inflation continued to rise, reaching a worrisome 5-6% by 1971. Richard Nixon enacted wage-price controls in August 1971, followed by less formal guidelines for wages and prices. Gerald Ford declared inflation “public enemy number one” and called for a campaign to Whip Inflation Now (WIN).
These steps failed to slow inflation, which reached an alarming 12% in 1975 and a disruptive 14% in 1980. Worse still, unemployment also rose! This distressing combination of rising inflation and rising job loss earned the moniker “stagflation” (stagnating job growth and rising inflation).
Clearly, the Phillips Curve was wrong. Accepting higher inflation did not protect jobs. So, a new analysis was needed.
In stepped economists associated with the Federal Reserve Bank of Minneapolis and the University of Minnesota, who argued that there was no trade-off between inflation and unemployment. You could fight inflation without fearing job loss by enacting strong, credible monetary policy. In particular, by announcing a change in policy from tolerating rising inflation to reducing inflation and showing that you meant it by slowing the growth of the money supply, inflation would fall but unemployment would not rise.
In October 1979, Paul Volcker (who had recently been appointed chair of the Federal Reserve) announced a change in policy along the lines advocated by the Minnesota economists. The Fed would no longer control interest rates but would focus on the growth of the money supply instead. This meant that interest rates could rise as high as the financial markets would take them, which they did, hitting 19 percent (on the federal funds rate) in January 1981.
Volcker had been advocating this type of policy as an assistant secretary of the Treasury in the early 1970s and as president of the Federal Reserve Bank of New York starting in 1975. He did not, however, believe that the Minnesota analysis was correct. Rather, Volcker argued that the only way to stop inflation was to throw the economy into a sharp, deep recession. It was the price America needed to pay.
In fact, these policies did put the economy into a deep recession that lasted until 1983. The Minnesota analysis of costless (or at least, low cost) inflation reduction was wrong.
But Volcker’s policies did stop the inflation scourge. Inflation fell from 14 percent in 1980 to 3 percent in 1983 and has stayed relatively low and stable ever since.
Lessons of the 1970s
Economists and those who make economic policy drew two important lessons from the 1970s experience:
- Don’t let inflation accelerate. It’s hard to stop once it gets going.
- If inflation starts to accelerate, raise interest rates, induce a recession, and kill off the increase in inflation.
As a result, a new synthesis emerged in macroeconomic theory as well, and that has been at the heart of much economic research since the 1980s. This framework has three pillars:
- There is a short-run trade-off between inflation and unemployment (and this justifies the Volcker approach).
- But, expectations about policy matter and thus we need to keep inflation under control so that people don’t expect higher inflation.
- Thus, in the long run, there is no trade-off between unemployment and inflation.
What do we do today?
There is no doubt that inflation has risen over the past year. Observers such as Lawrence Summers see this as a sign that we need to go back to the Volcker play book, that is, the Fed should raise interest rates and, if necessary, we must accept slower growth or even a sharp and deep recession to prevent inflation from getting out of hand.
They are fighting the last war. Just as policymakers in the 1970s were convinced that they had to prevent another Great Depression, Summers and other economists think that they must prevent another Great Inflation.
What if they are wrong? As I explained in a previous column, inflation today is different than the inflation of the 1970s. It’s not clear that raising interest rates and causing a recession would do much to reduce inflation. It might help, but only by throwing people out of work, reducing their incomes, and forcing them to spend less. This would take the pressure off supply chains and probably reduce the inflation rate.
However, we don’t want to treat a heart attack (runaway inflation) when all we have is a case of indigestion (mild inflation that will slow as the economy returns to post-pandemic stability). We need to diagnose the problem correctly and not fit everything into the paradigm of the 1970s.
Inflation today is affecting only certain sectors of the economy and is primarily the result of pandemic disruptions. All of this will calm down in the coming months, and no drastic measures are necessary at this time. In fact, big increases in interest rates and contractionary policies such as reducing federal spending would make us worse off economically.
Let’s use the correct historical analogy. Our inflation problems are akin to those we faced during the postwar reconversions of the 1940s and 1950s. Then, the Federal Reserve kept interest rates low and stable and inflation rates came down as the U.S. economy went back to a peacetime footing. This is the case from which we should draw lessons, not 1970s stagflation.
The Federal Reserve is ready to act against inflation if there is any sign that it is permanently accelerating. They learned the lessons of the 1970s and will do whatever it takes to keep inflation under control. In the meantime, they will resist being drawn into the wrong war at the wrong place at the wrong time.
At the high tech company I worked for in the mid to late 70s, the annual pay increases ranged from 10-15%. Of course, if you were in the market for a home or a gallon of gas you were out of luck.
And 5 years later the gallon of gas returned to lower pricing and you got to keep that 15% raise.
WIN!!!
Well the good news is we still have a Fed, and hopefully it is not politicized, anyone with cash knows it has been returning basically (0). So perhaps its time to slow the flow of the free money? That could possible also slow down foreign goods demand which may also help correct the supply chain mishaps of today, and no I do not claim to be an economist although I aced my Econ classes in college when the inflation was roaring!
How about we correct the things we can correct in our economy? There is no need for the cost of a barrel of gas going sky high with our oil and gas resources. It is plain stupid to ask OPEC and Russia to “please give us more oil” when all we need to do is drill here in the USA. Solving pieces of a puzzle is how you manage a crisis, evidently the Biden Administration struggles with that simple business model… In a crisis, fix what you can… Problem is that approach is not taught in college and most of Biden’s administration (Granholm) have no real world experience, career politicians!
Even drilling at a breakneck pace during the Trump years, we produced 13 million barrels/day, while we consumed 20million. That is a 7million barrels per day production shortfall, and no one except the propagandized on the Right thinks we can make up that shortfall no matter how much we drill. That, and three million of that was fracking, which has a short life geologically speaking, and lost a trillion dollars over a decade besides. So the investment money isn’t there anymore to chase after phantoms, even to get us back to 13million barrels/day.
So in other words, if we want cheap gas, there is no getting around begging OPEC and Russia to flood the market, which they are not going to do.
Mr. Duncan, in 2020 we exported 8.5 million barrels a day while importing 7.9 million barrels a day. The USA became a net exporter of oil for the first time since 1949. Biden’s policies changed that and gas is 65% more today than a year ago.
https://www.eia.gov/dnav/pet/hist/LeafHandler.ashx?n=pet&s=mcrfpus2&f=m
We are producing just over ten million barrels per day. Down from around 13 million in the heyday of fracking.
https://www.eia.gov/tools/faqs/faq.php?id=33&t=6
We consumed 18.19million barrels per day in 2020, which was low because of the pandemic. We are closer on average the last decade to 20mil/day.
So that “net exporter” is a lot like “energy independence”. Pure propaganda.
And then reading this page, it seems like what you are saying is true, until you realize that a lot of what they call oil is in fact petroleum distillates like natural gas, so one gets the sense that the EIA (Energy Information Administration) (like a lot of Institutions in America) is playing with the numbers to give the appearance that we are energy independent.
Fact is, if we were dependent on what we actually pull from the ground in North America, energy prices would be a lot higher and the American way of life would have to change radically.
https://www.eia.gov/energyexplained/oil-and-petroleum-products/imports-and-exports.php
Thank you for countering some of this “conservative” Oil Fever, WHD. The Oilers seem not to understand that the days of cheap oil (which is what they desire) are over. That’s because, all around the world, the known petroleum deposits which are easiest (hence cheapest) to access, are being pumped dry. Yes, it is likely that there are still some large, easy-to-access under-worked fields/deposits in Iraq, a country which has so far never been able to extract its cheap oil for a variety of reasons, which is why Cheney elected to fight Bush’s War to Liberate Iraq’s Oil from Saddam. But even the vast Saudi fields are running ever lower, which of course was inevitable. Oil fields aren’t bottomless.
So that leaves only oil deposits which require very specialized (hence expensive) methods of extraction. This includes the fracking, the tar sands and the deep oceans, be they arctic or otherwise. What the online Oil Fever boyz don’t understand is that if this oil is expensive to obtain, then it only makes sense to “access” if one knows that the price of a barrel will be high enough to cover the increased cost. And, as you say, the fracking fields turned out to be rather quickly depleted, as many speculated. The oilmen went after the best deposits, such as ND’s Bakken, and they started “drying up” rather quickly. And again, fracking is expensive. (We’ll leave aside the huge amount of water needed to frack, and the waste products produced, because Oil Fever guys like Joe couldn’t care less abut the environmental aspects of the problem….and of course the irreversible environmental dangers of drilling in arctic areas. Those carry no weight whatever.)
Ultimately there’s no way around the theory of Peak Oil, it’s all just a matter of time for world oil production to drop irreversibly. So, gas-guzzlers and oil fever guys, buy your monster pick-ups and drive your endless trains of semi-trailer trucks across the nation, keep your head in the (oil-depleted) sand. That’s the real problem, not that Biden proposed altering a few oil and gas lease programs over the course of a year…
Yes, in the main. Though the Biden Admin did just open up a large part of the Gulf of Mexico. And his protestations to OPEC are in contrast to his shutting down of Keystone XL, and really to his lack of real action on renewables.
All this it should be pointed out, is quite the pickle for a renewable utopia that otherwise looks exactly like market consumerism. That expensive to reach oil is necessary to build that renewable utopia.
Since Keystone XL was just a means to get North American petroleum resources to the docks in Nederland TX for export you must be very pleased to see Biden shut it down…
The takeaway isn’t whether the US should pump more or less oil. The US should make it’s economy much less dependent on fossil fuels.
Yes, a lot has changed since 1970. Global population more than doubled. As did energy consumption. It’s a finite planet. Something has to give. Inevitably.
My guess is too, the Fed is out of options. The only thing floating equities at this point is the Fed printing $120 billion every month to flood the market with (which is NEVER accounted in inflation) and low interest rates so private equity can take out unlimited loans at near zero interest to buy up the wreckage of the Covid economy with. Like this article, they are assuming pre-pandemic normality will return gradually, so it’s is simply a matter of maintaining the status quo – because there is no alternative, as far as the Fed is concerned.
There is also the pesky matter of price gouging, corporations using the pandemic as an excuse to raise prices, which only serve to further enrich investors and executives. But we don’t hear about that either. Mostly we hear about pandemic induced supply chain problems, and rising wages, or in other words, blaming working people.
If we’re going to look for historical analogies to deal with inflation, shouldn’t we be looking beyond the Federal Reserve to deal with it? I tried to understand inflation during the 1970’s and 1980’s when inflation was last a serious political issue in this US and came to the conclusion economists did not agree among themselves about the causes or the cures for it. The best explanation I found was in a book by the late William Greider called “Secrets of the Temple” who explained how Volker’s use of Milton Friedmanite monetarist policy-controlling the supply of money- ended “discrediting” monetarism.
Try explaining that to a “conservative” or “libertarian” today. Their solution is a “free market” solution which I suppose is returning the US to the gold standard and following the advice of Andrew Mellon to Herbert Hoover to end the Depression: “Liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate.”
Thanks for this trip down memory lane and for the macroeconomic analysis.
It should also be noted that the current inflation is a worldwide phenomenon, which would strongly indicate that the fiscal policies of the US of A are not to blame, nor that altering US fiscal policy would make much of a difference. One supposes that a monetary approach could have an effect, but that may be using a hammer to kill a mosquito. It does seem likely that should the inflation become more general that the current Fed will act on interest rates.
Strange how there was no war against the more than a decade long run of below target inflation that lead up until now.
Again, fix what you can. Why ask OPEC and Russia to drill more for us when we have th3 resources here in USA? This is how folks who have never run a business act, they do not nothing but talk a lot about what they should do. Much easier to demand 1.7TRILLION (for BBB nonsense) from taxpayers than open up drilling on Federal land and let Keystone pipeline finish their line.
Again, you seem to think that there are huge deposits of easy-to -access oil in US territory. There aren’t. The great fields of America have been pumped dry; the recent increase in production was largely shale oil, which is expensive oil. The idea that the US can “pump” (really frack) its way out of its oil-addicted predicament is ridiculous, no matter how many times “conservatives” repeat it.
What’s going on (short term) is that demand for oil contracted during the pandemic, which meant that price/barrel started to decline. In order to bolster prices the world oil cartel(s) naturally reduced production, meaning supply fell. Now (post vaccine) demand is again rising, but with a currently-reduced world supply, oil prices are rising. It’s simple economics, applied to oil markets.
The idea that Biden has promulgated some oil policy that immediately reduced America’s production is absurd. As is the idea that the US can somehow increase oil production on a moment’s notice. We aren’t Saudi Arabia, that’s not how we produce oil anymore. And again, you apparently cannot comprehend the reality that the means by which we are scraping the bottom of the oil deposits in the US are all expensive, meaning that the price per barrel has to be relatively high in order to justify the production.
The days of cheap oil are very likely over, Joe. There may be some peaks and valleys in price as the woeful 21st Century groans along, but the trend will be relentlessly upward. And all the supposed expensive-to-access “reserves” of the US can’t really alter that fact. Too many countries are using too much oil, a precious, irreplaceable resource which shouldn’t be essentially poured down the rat hole on such things as driving monster pick-ups around metro areas, among several dozen absurd wasteful practices that are ongoing in the Land of Freedumb.
And the idea that some sort of “business experience” is necessary to understand this or to deal with world oil cartels is silly. But even if it were the case, one would surely need to have better “business experience” than being compelled to file serial bankruptcies while running casinos, which are essentially licenses to print money!
Joe, you DO understand that the subject here is inflation right? Since oil production isn’t the cause of this inflation it makes little sense to pretend that focusing on oil will solve the problem or even explain the problem. Meanwhile the world economies are dealing with the obvious fact that we need to transition into more sustainable energy sources rather than cling to unsustainable sources. And your observations regarding oil supply and production are clearly not reliable.
You think the price of gas is the only thing the country has to worry about? You don’t think there could be more urgent priorities facing the country than how much it costs to fill the tank on an SUV?
Our roads and bridges might be crumbling, but it better be cheap to drive over them!
I think this commentary reveals yet another example of just how wrong “economists” can be. The scientific pretense in this field and it’s thin credentials are always worth noting. Nevertheless, I have to agree with Mr. Johnston here, we’re looking at crises almost completely driven by pandemic supply chain issues that will eventually abate. Meanwhile for those of us who lived through the 70s and 80s it is kind of funny to see these kids today freak out a little simply because we actually have to talk about inflation for the first time in what? 30 years?
Lots of wishful thinking going on that inflation is only affecting limited parts of the economy and is totally caused by the pandemic. From where I sit, the cost of EVERYTHING is going up. Gas, groceries, cars, airline tickets, hotel rooms, etc. Fundamentally this is a direct result of the government printing unlimited amounts of money. The fact that we now see inflation across the globe is just a reflection that governments everywhere are doing the same thing: printing money. This is going to end the same way it did in the 70s. Eventually interest rates are going to go thru the roof and we are going to have a major recession. The longer we put that off, the worse it’s going to be.
This is the standard conservative argument and I’m pretty sure it’s claptrap, especially when the Fed hasn’t made the slightest move to increase interest rates. And no, not “all” governments responded to the pandemic by “printing money”, Europe crazily followed a much more financially austere policy. Furthermore, the US stimulus spending that took place in 2020 and earlier this year simply made up for collapsed consumer demand, as the money was mostly sent to strained households. So no, that wasn’t inflationary spending either.
As for the current budget bills (whose amounts “conservatives” are now throwing about with such feigned alarm), those amounts (if approved) will be spread over 10 years, and you can’t name a serious economist who thinks such spending will be inflationary. Commodities (like food and oil) experienced reductions in supply during the pandemic, as did things like hotel rooms. They likely will moderate as supply returns to normal (and you don’t need to buy hotel rooms, anyway.) It is possible that a general increase in paying living wages will permanently raise prices in industries that had previously relied on cheap labor. This is the sort of inflation that a civilized nation needs, however.
So this is (mostly) supply constraint inflation, and that’s the current consensus opinion, as far as I can tell. In any event, “conservative” politicians (who have never understood anything about macroeconomics and never will) surely will have no answer to inflation, other than perhaps echoing your glib comment to bring on a “major recession”, which wouldn’t be a popular political position! Hopefully more sensible voices will remain in charge…
BK, it’s always kind of amusing the way Republicans flip flop around regarding persistent economic observations depending on who’s in the executive chair at the time. Deficits are irrelevant when a Republican is in the oval office but a disaster otherwise. Everything’s coming up roses when Trump sits in the big chair but the exact same economy is portent of the coming apocalypse once Biden steps through the door (as if there would be no supply chain issues or inflation had Trump won).
And no, liberals and Democrats don’t run the same game, we see inflation as inflation regardless, etc. etc. And even if Democrats did play the same game… it would wrong to do so, therefore no consolation or justification for Republicans. You’re still wrong when your wrong in this world no matter who else is wrong as well.