Tue Jul 12th, 2022 at 06:35:52 PM EST
Is 1970s-Style Inflation Coming Back?
With commodity prices soaring, money supply growth exploding, and government spending surging, there is a palpable fear of a return to 1970s-style inflation. I get it. I remember those times. Bell bottoms, long hair, aviator glasses, and disco music were popular. (Although I confess to embracing the fashions of the era, I was never a disco fan.)
It wasn't all frivolous, though. In fact, it was a tumultuous time both socially and economically. The era opened with the Kent State shootings, unfolded into Watergate and President Richard Nixon's resignation, hit a crescendo with the fall of Saigon, and ended with the Iranian hostage crisis. In the middle, there was an economically crippling oil price spike, a deep recession, and high inflation. It's the memory of high inflation that seems to strike a nerve with investors.
Today's inflation and the Great Inflation of the 1970s: Similarities and differences
The period of high and variable inflation rates of the 1970s offers some salutary lessons for the current period. In our new CEPR Policy Insight, we examine the main similarities and differences between the current juncture and the 1970s to shed light on the question of whether we are witnessing the end of the era of low inflation (Ha et al. 2022). Echoes of the Great Inflation of the 1970s and fading structural forces of disinflation may be reasons to believe so; expectations that recent cyclical shocks will subside, and decades of building central bank credibility and anchoring expectations, may be reasons to disagree.
Déjà vu all over again: Similarities to the 1970s
In light of the experience of the 1970s, the case for a protracted period of high inflation is straightforward. First, supply disruptions driven by the pandemic and the recent supply shock dealt to energy prices by the war in Ukraine resemble the oil shocks in 1973 and 1979-80. Second, then and now, monetary policy was highly accommodative in the run-up to these shocks (Figure 2a). After several months of above-target inflation in major advanced economies, a steeper-than-anticipated policy tightening might now be required to return inflation to target - and this might trigger a hard landing similar to that of the early 1980s (Blanchard 2022, Summers 2022, Gagnon 2022).
Differences from the 1970s
There are important differences between the current situation and the 1970s. First, at least thus far, the magnitude of commodity price jumps has been smaller than in the 1970s. In the wake of major oil shocks, oil prices quadrupled in 1973-74 and doubled in 1979-80. The combination of high inflation with weak economic growth, fuelled by repeated supply shocks, gave rise to the phenomenon of `stagflation'. Today, oil prices are, in real terms, still only around two-thirds of those in 1980 or 2008.
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Through increasingly unscrupulous monetary policy, U.S. government officials mask the costs of war from the American public. Bitcoin could fix this.
Kreps's book relies on historical tax, bond and spending data, as well as public opinion polling about war going back a century. One major takeaway, though seemingly obvious, is that taxed wars are less popular than untaxed wars.
"A war financed through higher taxes," she observes, "decreases support by about 20% compared to the baseline scenario without taxes."
American elected leaders know this, and since Vietnam have sought other ways to pay for wars. This was on display during the peak of the Iraq War in 2007, when Congressmen John Murtha and Jim McGovern proposed a war tax to finance the surge. It was based on a sliding scale, something that columnist E.J. Dionne called the "rare Democratic proposal that does not put the entire burden of taxation on the rich."
But House Speaker Nancy Pelosi rejected the war tax, saying it was "not a Democratic proposal," and hinted that the Democrats would suffer at the ballot box if they tried to push it through. As Kreps notes, "debate was perfunctory and questions about the potential effect of a war tax on support for the war were glossed over."