Unlike the stagflation of the 1970s, the US recovery from the pandemic-induced recession has been strong, whether judging by GDP or labor market indicators. Today’s economic conditions are therefore reminiscent of the late 1960s, another period of rapid growth and moderately rising inflation.
CAMBRIDGE – Are the United States and other advanced economies experiencing stagflation, the unfortunate combination of high inflation and low output and employment growth that characterized the mid-1970s? At least in the case of America, the answer is no. What the United States is currently facing is moderate inflation, without the stagnant part. It’s reminiscent of the 1960s, not the decade that followed.
To be sure, headline consumer price inflation in the United States hit an unexpected level of 6.2% in October, the highest rate since 1991. Few people still predict a rapid return to 2% inflation , the long-term goal of the US Federal Reserve. Inflation has also reached ten-year highs in the United Kingdom (4.2%) and the European Union (4.4%), although it remains low in Japan.
Unlike the stagflation of the 1970s, however, the U.S. recovery from the pandemic-induced recession of 2020 has been strong, judging by GDP and labor market indicators. Growing demand for goods is facing supply constraints, including bottlenecks in ports and shortages of chips, leading to price inflation. Meanwhile, growing demand for labor is meeting a labor supply constrained by the lingering effects of the pandemic. This has resulted in wage inflation.
The U.S. unemployment rate fell from 14.8% in April 2020 to 4.6% in October 2021, which would have been considered close to full employment for most of the past half century. In contrast, unemployment reached 9% in May 1975, during a period of stagflation. Other current indicators point to an even tighter labor market today: the ratio of job vacancies to the unemployed is the highest on record, as is the quit rate. Wage growth is also on the rise, particularly at the lower end of the wage distribution.
Only participation in the labor market remains significantly depressed. Part of the decline reflects retirements, but much of it is attributable to COVID-19.
Evidence suggests that the problem with the US economy is not insufficient demand, which monetary and fiscal expansion could remedy, but rather inadequate supply, which they cannot. In particular, nominal GDP and direct measures of domestic demand, such as real personal spending or retail sales, have resumed their pre-pandemic long-term trends. When demand exceeds supply, the result is a trade deficit and inflation. We are currently seeing both.
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These are, in a sense, good problems to have. It is clearly better for demand and supply to recover, even if demand rebounds faster, than neither does. The US economy is way ahead of what most thought it would be a year ago. It is also ahead of other countries, such as the UK affected by Brexit, as GDP is now above its pre-pandemic level.
Monetary policy can do nothing to ease capacity constraints. But those constraints could go away on their own over the next year or so, as ports unclog, supply chains reform, the most demanding workers successfully match the jobs they want and the jobs they want. that supply responds to the high prices of those particular sectors facing acute excess demand.
Rather than looking like the 1970s, therefore, the current period is perhaps more like the late 1960s, another period of rapid growth and tight labor markets. Consumer inflation reached 5.5% in 1969.
Some fear that today’s moderate inflation will eventually be built into expectations, trigger a wage-price spiral, and resemble the high and persistent inflation of the 1970s. It is not impossible, and we do not. should not be complacent about inflation. But policymakers are unlikely to repeat the mistakes made at the time.
These mistakes started with increasing government spending to finance the Vietnam War without the tax revenue to pay for it. They continued in 1971, when Fed Chairman Arthur Burns and President Richard Nixon responded to rising inflation with a combination of quick monetary stimulus and doomed wage and price controls. failure. An overheating economy blew the lid off the boiling pot a few years later and inflation topped 12%.
Admittedly, the Fed has been overly optimistic in its inflation forecast this year, expecting price increases to be weaker and more transient. Larry Summers and Olivier Blanchard got it right in February, when they correctly predicted that rapid growth would lead to inflation.
But even though the Fed’s inflation forecast was far from target, its stocks arguably fell short of target. Granted, the Fed didn’t expect to start cutting back on its monthly asset purchases – known as quantitative easing – as early as November 2021. But it has responded appropriately to incoming inflation data, as well. than on the strength of the economy, adjusting the timing of its plans.
Additionally, markets barely reacted to the taper’s announcement of November 3, indicating that (now re-appointed) Fed Chairman Jerome Powell had successfully communicated the central bank rethink – unlike in 1994 and 2013, when the investors had not anticipated the onset of tightening cycles. If the Fed starts raising short-term interest rates in mid-2022, that won’t surprise the markets either.
President Joe Biden can do relatively little to stem the highly unpopular rise in inflation. It has already stepped in to help unblock ports and other logistics in the supply chain. Increased vaccination against COVID-19 would increase labor supply, for example by keeping children in school, although it is difficult to see what more Biden could do here.
A good way to moderate inflation would be to allow more imports. Former President Donald Trump’s tariffs on many products – including aluminum and steel, and nearly all U.S. imports from China – have pushed up prices for consumers. Biden should be able to persuade China and other countries to lower some trade barriers against the United States in exchange for the removal of American tariffs. In any case, trade liberalization could bring some prices down quickly.
Some argue that the new government spending envisioned in Biden’s social spending bill would help increase inflation, either because they disapprove of big government or because a dollar of spending increases demand more than it does. a dollar of tax revenue reduces it. Others believe that the net effect on inflation will be beneficial (especially in the longer term), as many of the planned programs, such as quality universal preschool education, will increase the labor supply. artwork.
Regardless of these arguments, the effect of the new legislation on inflation is expected to be minor. Biden’s infrastructure package and proposed social spending should be judged on their own merits. Rising inflation in the United States reflects the economy’s rapid recovery from the COVID-19 recession, which means we should stick our heads out from the 1970s.