When it comes to inflation, it never comes back

The writer is chief global economist at Morgan Stanley

Easy monetary policy, expansionary fiscal policy, rising inflation and then high oil prices – it is very difficult to resist the temptation to compare with the 1970s.

However, I would suggest, current conditions are not a repeat of that decade, doomed to end in a deep, political-induced stagnation that is dragging much of the world down. There are several meaningful reasons why today is not yesterday. Having said that, even if we’re not in the ’70s, we’re not on an easy path.

In the latter half of the 1960s, the US economy grew more tightly due to stimulus fiscal and monetary policy. The first oil price shock in the early 1970s increased inflation. So far, the comparison is good with today, but the differences soon became apparent.

The economy’s dependence on oil is much less now than it was in 1970 – largely because services now account for a much larger share of GDP. In fact, now that the United States has become the world’s largest oil producer, there is now a boost to at least one part of the economy.

Of course, inflation is the percentage change in prices, and looking at this lens, oil price shocks today aren’t very close to what they were five decades ago.

At the end of 2019, just before the onset of the COVID-19 pandemic, oil was around $60 a barrel; It’s now almost double that price. In 1970, West Texas Intermediate crude, the benchmark for US oil, was just over $3 a barrel. In 1974, after the first sharp rise in inflation, it moved to more than $10 a barrel—three times the price. By 1980, the barrel price approached $40, or more than 10 times its starting price. Doubling oil prices is a big deal. Increasing by an order of magnitude is something completely different.

In the 1960s, widespread inflation began, with prices of both goods and services rising. In the past year, inflation has started narrowly, with consumer demand rising as global supply has been unable to keep pace with a sclerotic supply chain crippled by the coronavirus pandemic.

Right now, of course, inflation has spread across all categories in the CPI, but commodity inflation looks set to roll back. Consider recent earnings reports from retailers who are overstocked and trying to offload stock. Excessive spending on consumer goods appears to be about to correct, and with it, at least part of the inflationary pressures.

However, the current scale of inflation is undeniable, and there are concerns from the 1970s that it might take hold in the economy. Indeed, some long-term measures of inflation expectations are now beginning to rise.

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But consider this: In 1970, anyone aged 40 or older had already experienced three bouts of hypertrophy similar to those of the present. Today’s 40-year-olds have never seen anything that can compare, and they are actually more familiar with deflationary trends than inflationary trends.

In 1970, the thought must have been, “Here we go again,” while the question today is, “What’s next?”

Ultimately, former Federal Reserve Chairman Paul Volcker set out to extract decade-long inflation from the US economy in 1979 by sharply raising interest rates and triggering a recession. (I’m happy to leave aside the implications of whether the Fed raised interest rates or just restricted money growth; that’s an indiscriminate difference in this case.)

But by then, there was a decade of high inflation, deeply ingrained in the mindset of companies and families who were already very familiar with high inflation. The effort required to break that cycle was very different from what was required to curb the excesses of the day.

This point may lead to the biggest difference of all. We can learn from history if we so choose.

Reams of papers have been filled in explaining how and why “super inflation” took hold, but in all the analyzes the very easy monetary policy figures feature prominently. Incumbent Federal Reserve Chairman Jay Powell has seen the cost of lowering inflation in Volcker and has already begun to purposefully tighten policy. To be sure, Powell would need skill, grit and not a little luck, but – starkly compared to Volcker’s predecessor, J. William Miller – he knows what happens if high inflation is left unchecked.

But even if I’m right that we don’t live relive the ’70s, the road ahead is not so rosy. It is undeniable that inflation is very high, and a large part of it is in basic services, driven by an economy trying to buy far more than it can comfortably produce.

Any empirical estimates of how much slack the economy would have to generate to lower structural inflation represents a very unpleasant trade-off. Either the Fed can bring down inflation quickly by causing a meaningful recession, although likely milder than it was in 1979, or it can slow the economy just to shy away from recession, but live with higher inflation. In the next few years. Judging by the expectations of the FOMC members at their last meeting, they chose the latter path. But, as you pointed out, luck will also play a role.

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