This will be the second blog post that's come out of my efforts to try to finish my talk for Commonwealth’s National conference. If you remember, in the previous post, the question was whether we were headed back to the 1970s, with all that implies (inflation, stagflation, high unemployment, disco), or back to the 1950s (which, for all its faults, did not have disco).
To try to figure that out, this morning I spent quite a bit of time looking at long-term inflationary trends over the past 70 years. The data gets iffy beyond about 1955, but there were some really interesting observations that will feed into my discussion. First, general inflation trends tend to last between 10 and 20 years, sometimes longer. Second, the period from 1970 to about 1990 was an anomaly, compared to the decades before and after. Inflation was quite high during that time, but it has been contained both before and after. Third, when you look at overall price levels—not the annual change in prices, but the price index itself—there have been only two episodes when price changes really accelerated: from about 1970 through 1980 and from 2021 to the present.
Over those time periods, high inflation has really been an anomaly. You can argue that, over time, lower levels of inflation add up, and that is certainly true. But to get the kind of massive year-on-year price increases we have seen recently simply is not that common. So, the question we have to answer is why those two periods had such high inflation—and do we see those conditions now?
Shocks to the System
This takes us to shocks versus changes in trend. In both of those cases, there were enormous shocks to the system. In the 1970s, it was the oil price spike, which then fed through into more general price inflation, through wages and everything else. Because of that pass-through, inflation got entrenched into a wage price spiral and just proceeded to get worse until the Fed put the economy through two recessions to get rid of it. The shock was certain. But what made it worse was that the shock was allowed to turn into a change in trend over time.
When we look at today, we certainly have our share of shocks. The pandemic, the Ukraine war, the ongoing deglobalization of the world economy, and the U.S. labor shortage come to mind immediately. The question is whether those will lead to a change in trend, leaving inflation higher permanently for years to come.
A Change in Trend?
Thus far, the answer seems to be no. Most of the inflation here in the U.S. has been driven by three things: energy costs, food costs, and shelter costs. All three of these are running well above other components and have pulled the overall inflation rate up. All three of these are, however, also starting to correct and, as they correct, will pull inflation back down. Like other spikes we have seen, they appear to be fading and, as they do, will pull inflation back down.
Another factor that should help push inflation down, and prevent a change in trend, is that the Fed is now taking preemptive action, which will help prevent a wage price spiral based on expectations.
That said, we will likely see inflation at higher levels than we have seen in the past decade. Oil will likely be more expensive, and wages will grow faster. A less efficient global economy will keep supplies tighter and prices higher. But that doesn’t mean we are back to the 1970s. Rather, it’s more that we are back to the 1950s, where we saw a steady range of inflation, or, for that matter, back to the 1990s.
Will Inflation Subside Sooner Than We Think?
There are some good arguments against this conclusion, which I am still thinking through. But for the moment, the data suggests that this bout of inflation is due to shocks and not a change in trend. That the Fed is doing the right thing, and it is working. And that this inflation will subside—perhaps sooner than we think.