Question: Is it the ‘70s all over again?
Mate27
TUSCL’s #1 Soothsayer!
Friday, November 18, 2022 4:01 AM
I think we all know my opinion on this matter, but better to let you opine if so inclined. TLDR, it’s not the 70s man!
https://www.reuters.com/article/sponsore…
By: Erik Weisman, Chief Economist, Fixed Income Portfolio Manager
MFS Chief Economist Erik Weisman examines the important similarities and key differences between today’s elevated inflationary environment and the high inflation levels of the 1970s.
Similarities
Guns and butter. In the 1970s, a decade infamous for runaway prices, a variety of factors coalesced to send inflation soaring. Some of these factors first appeared as early as the 1960s, when the United States, enmeshed in a war in Vietnam and facing the Cold War threat of the Soviet Union, pursued a policy of both guns and butter as the government spent lavishly on both defense and on social programs. That backdrop is somewhat analogous to what we’re experiencing today, with high military spending in the US and rapid increases in defense outlays across Europe due to Russia’s actions in Ukraine and along with them a rise in social spending as baby boomers age. And if the government’s response to the pandemic is any indication, more generous government benefits in the US down the road. In other parts of the world, bountiful safety nets and experiments with things such as universal basic income programs suggest a more robust approach to social welfare.
Oil and food. The most obvious similarity between the seventies and today is the elevated price of oil. The OPEC oil embargo in 1973 and the Iranian revolution in 1979 disrupted global energy supplies. Today, it’s Russia’s invasion of Ukraine and its impact on supplies of oil and natural gas that is roiling markets. The invasion has also had the knock-on effect of severely impacting global food supplies as Ukraine struggles to export grain and Russian shipments are limited by international sanctions. Shortages were also a factor in the surge in food prices in the seventies. Amid poor harvests in the Soviet Union and elsewhere in the early part of that decade, the US sold subsidized shipments of grain to the USSR, which contributed to a global shortage.
Misjudging economic slack. Another similarity with the seventies is that the US Federal Reserve misjudged some important fundamentals of the economy both back then and again over the past year or so. In the seventies, the Fed was under the assumption that there was a large negative output gap, which it assumed meant it could wait before raising rates. We now know that the output gap in those days was quite positive, meaning the economy was operating well above potential, only turning negative during the recessions, leading to persistently high inflation.
In the seventies, the Fed was under the assumption that there was a large negative output gap, which it assumed meant it could wait before raising rates.
Just as inflation was rebounding from near zero in the wake of the global lockdown during the early phase of the pandemic, the Fed, after a decade of missing its inflation target on the downside, adopted a flexible average inflation target. This meant that to make up for years of inflation under 2%, the Fed would let inflation run above target for a while so it would average out over time. The central bank’s timing couldn’t have been worse. COVID-related bottlenecks, labor shortages and a shift in consumption patterns from services to goods caused prices to rise quickly. The Fed thought those factors were transitory and was slow to react. Now it has been forced to make up for lost time.
Labor strength. In the seventies, membership in labor unions was much higher than it is today and many wage contracts were indexed to inflation, so paychecks rose with prices. Today, unionization is a fraction of what it was five decades ago. However, given tight labor markets and demographic trends, workers appear more powerful today than they’ve been in many years and unionization is seeing a modest uptick, though it’s too early to say whether that trend can be sustained.
Differences
Loose macro mix. The mix of fiscal and monetary policies in the seventies was persistently loose, leading to a long period of excessive monetary liquidity. Today, policy is relatively tighter, notwithstanding the exceptionally large levels of stimulus added to the economy during and just after the depths of the pandemic. Indeed, most of the recent extraordinary monetary and fiscal loosening lasted only a year, compared to almost a decade in the seventies.
Central bank independence and inflationary expectations. Central banks are more independent today because of reforms undertaken after the seventies inflation episode, leading to greater credibility and better anchored inflation expectations now.
Real wage growth. In the seventies, wage growth quite frequently outstripped inflation, which helped contribute to a wage/price spiral as workers had the resources to spend freely, which contributed to price rises, and so on. Today, wage growth is falling well short of inflation on average, resulting in historically negative real wage growth.
Central banks are more independent today because of reforms undertaken after the seventies inflation episode, leading to greater credibility and better anchored inflation expectations now.
It’s not the ’70s, but…
While some of the factors that drove inflation higher in the 1970s are analogous to the situation today, others are very different. But if inflation is to remain way above target, real wages, in my view, would need to be at least marginally positive and the Fed would have to continue its error of not tightening sufficiently. While I think it’s unlikely to play out this way, the Fed would have to be unwilling to inflict the necessary pain on the labor market to get inflation under control. I think the more likely scenario is that the Fed frontloads policy too much, throwing the economy into a meaningful recession, pushing inflation rapidly back down toward target.
But if inflation is to remain way above target, real wages, in my view, would need to be at least marginally positive and the Fed would have to continue its error of not tightening sufficiently.
Where things get tricky is if inflation declines but stabilizes at higher than target (say around 3.0% to 3.5%). Policymakers might at that point decide the damage to the economy caused by further tightening to hit their inflation target isn’t worth it.
While I don’t think we’ll see the persistently high inflation levels of the seventies, I do think we could end up with inflation that is more akin to the high 2% range that prevailed during the two business cycles that preceded the global financial crisis (roughly, the 1990s and most of the 2000s) than the sub 2% average we witnessed during the post-GFC cycle (the 2010s). That is to say, the exceptionally low inflationary environment of the post-GFC cycle is likely not the right template for thinking about the inflation regime of the future.
Can your fixed income strategy navigate shifting market dynamics? Find out how.
The views expressed are those of the author(s) and are subject to change at any time. These views are for informational purposes only and should not be relied upon as a recommendation to purchase any security or as a solicitation or investment advice. No forecasts can be guaranteed.
The Reuters editorial and news staff had no role in the production of this content. It was created by Reuters Plus, part of the commercial advertising group. To work with Reuters Plus, contact us here.
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https://www.reuters.com/article/sponsore…
By: Erik Weisman, Chief Economist, Fixed Income Portfolio Manager
MFS Chief Economist Erik Weisman examines the important similarities and key differences between today’s elevated inflationary environment and the high inflation levels of the 1970s.
Similarities
Guns and butter. In the 1970s, a decade infamous for runaway prices, a variety of factors coalesced to send inflation soaring. Some of these factors first appeared as early as the 1960s, when the United States, enmeshed in a war in Vietnam and facing the Cold War threat of the Soviet Union, pursued a policy of both guns and butter as the government spent lavishly on both defense and on social programs. That backdrop is somewhat analogous to what we’re experiencing today, with high military spending in the US and rapid increases in defense outlays across Europe due to Russia’s actions in Ukraine and along with them a rise in social spending as baby boomers age. And if the government’s response to the pandemic is any indication, more generous government benefits in the US down the road. In other parts of the world, bountiful safety nets and experiments with things such as universal basic income programs suggest a more robust approach to social welfare.
Oil and food. The most obvious similarity between the seventies and today is the elevated price of oil. The OPEC oil embargo in 1973 and the Iranian revolution in 1979 disrupted global energy supplies. Today, it’s Russia’s invasion of Ukraine and its impact on supplies of oil and natural gas that is roiling markets. The invasion has also had the knock-on effect of severely impacting global food supplies as Ukraine struggles to export grain and Russian shipments are limited by international sanctions. Shortages were also a factor in the surge in food prices in the seventies. Amid poor harvests in the Soviet Union and elsewhere in the early part of that decade, the US sold subsidized shipments of grain to the USSR, which contributed to a global shortage.
Misjudging economic slack. Another similarity with the seventies is that the US Federal Reserve misjudged some important fundamentals of the economy both back then and again over the past year or so. In the seventies, the Fed was under the assumption that there was a large negative output gap, which it assumed meant it could wait before raising rates. We now know that the output gap in those days was quite positive, meaning the economy was operating well above potential, only turning negative during the recessions, leading to persistently high inflation.
In the seventies, the Fed was under the assumption that there was a large negative output gap, which it assumed meant it could wait before raising rates.
Just as inflation was rebounding from near zero in the wake of the global lockdown during the early phase of the pandemic, the Fed, after a decade of missing its inflation target on the downside, adopted a flexible average inflation target. This meant that to make up for years of inflation under 2%, the Fed would let inflation run above target for a while so it would average out over time. The central bank’s timing couldn’t have been worse. COVID-related bottlenecks, labor shortages and a shift in consumption patterns from services to goods caused prices to rise quickly. The Fed thought those factors were transitory and was slow to react. Now it has been forced to make up for lost time.
Labor strength. In the seventies, membership in labor unions was much higher than it is today and many wage contracts were indexed to inflation, so paychecks rose with prices. Today, unionization is a fraction of what it was five decades ago. However, given tight labor markets and demographic trends, workers appear more powerful today than they’ve been in many years and unionization is seeing a modest uptick, though it’s too early to say whether that trend can be sustained.
Differences
Loose macro mix. The mix of fiscal and monetary policies in the seventies was persistently loose, leading to a long period of excessive monetary liquidity. Today, policy is relatively tighter, notwithstanding the exceptionally large levels of stimulus added to the economy during and just after the depths of the pandemic. Indeed, most of the recent extraordinary monetary and fiscal loosening lasted only a year, compared to almost a decade in the seventies.
Central bank independence and inflationary expectations. Central banks are more independent today because of reforms undertaken after the seventies inflation episode, leading to greater credibility and better anchored inflation expectations now.
Real wage growth. In the seventies, wage growth quite frequently outstripped inflation, which helped contribute to a wage/price spiral as workers had the resources to spend freely, which contributed to price rises, and so on. Today, wage growth is falling well short of inflation on average, resulting in historically negative real wage growth.
Central banks are more independent today because of reforms undertaken after the seventies inflation episode, leading to greater credibility and better anchored inflation expectations now.
It’s not the ’70s, but…
While some of the factors that drove inflation higher in the 1970s are analogous to the situation today, others are very different. But if inflation is to remain way above target, real wages, in my view, would need to be at least marginally positive and the Fed would have to continue its error of not tightening sufficiently. While I think it’s unlikely to play out this way, the Fed would have to be unwilling to inflict the necessary pain on the labor market to get inflation under control. I think the more likely scenario is that the Fed frontloads policy too much, throwing the economy into a meaningful recession, pushing inflation rapidly back down toward target.
But if inflation is to remain way above target, real wages, in my view, would need to be at least marginally positive and the Fed would have to continue its error of not tightening sufficiently.
Where things get tricky is if inflation declines but stabilizes at higher than target (say around 3.0% to 3.5%). Policymakers might at that point decide the damage to the economy caused by further tightening to hit their inflation target isn’t worth it.
While I don’t think we’ll see the persistently high inflation levels of the seventies, I do think we could end up with inflation that is more akin to the high 2% range that prevailed during the two business cycles that preceded the global financial crisis (roughly, the 1990s and most of the 2000s) than the sub 2% average we witnessed during the post-GFC cycle (the 2010s). That is to say, the exceptionally low inflationary environment of the post-GFC cycle is likely not the right template for thinking about the inflation regime of the future.
Can your fixed income strategy navigate shifting market dynamics? Find out how.
The views expressed are those of the author(s) and are subject to change at any time. These views are for informational purposes only and should not be relied upon as a recommendation to purchase any security or as a solicitation or investment advice. No forecasts can be guaranteed.
The Reuters editorial and news staff had no role in the production of this content. It was created by Reuters Plus, part of the commercial advertising group. To work with Reuters Plus, contact us here.
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6 comments
Just a little point since the fed and the legislature run nearly entirely independent of each other their differing goals can lead to them neutralizing each other and if congress subsidizes the workers who have lost real income the consumer will now have steady total spending power removing the downward pressure on prices
Our political leadership is worse now. Reagan supported Volcker in his fight against inflation. Powell is no Volcker and Biden is no Reagan. When raising interest rates pushes the country into a harsh recession, the Fed will be unlikely to stay the course. It will lower interest rates and inflation will resume. People say the U.S. is not some third world banana republic like Venezuela or Zimbabwe that will let inflation get out of control. The U.S. today, though, is not the U.S. of 40 years ago when we last successfully fought inflation.
This is by far different than previous generation of inflation. The middle class isn’t as strong as it was when the unions had more power, and the money was extremely loose for too long. Todays productivity is a lot higher with technological advances made in the past 40 years. If anything, we are in danger of deflation especially if world central banks keep tightening and we get into currency wars, which is a real possibility.
Boring stuff for most people, until you realize all economies are interconnected. The time value premium is do you spend it now, or hope to earn $$ of that for future purposes? Most people have the mentality of what they could do with it last year or right now, not what can be done with it going forward.
What do you call having the interest rate buried at fucking zero for 8 years before Trump came to office and even then only nudging it up a bit? For 14 years the markets and the economy had become accustomed to artificially cheap money. Now the chicken has come to roost.
===> "Real wage growth. In the seventies, wage growth quite frequently outstripped inflation, which helped contribute to a wage/price spiral as workers had the resources to spend freely..."
No, wage growth typically lagged inflation, which then led to employee demands (largely though unions back then) to increase wages. Prices then went up when employers passed the cost along to consumers. This is the classic wage/price spiral.
Do you ever do your own thinking Mate or do you always rely upon other grown men to do it for you? 😉
1. consumers buying houses, cars, and everything else. Raising rates has already tamped this down by raising rates.
2. Dramatic increase in money supply. Fed is addressing this very gradually.
3. energy prices affected by supply constraints, including Russian sanction and Biden attack on oil industry. No one is doing anything about this
4. Supply chain problems cut supply of good resulting in higher prices.Chinese policies have caused this and problems will continue for years until production returns to North America.
5. Congress passing multiple, trillion dollar, spending frenzies. In theory, a Republican Congress could freeze this but Mitch MConnel has caved another trillion right now.
Inflation will ease somewhat but it will be a couple years before it reaches the target rate of 2%.