Three reasons why inflation today is different from the 1970s
For a generation of Americans, inflation worries went the way of leisure suits and disco balls.
Now it’s back in the headlines. December’s 7% inflation rate was the highest in 40 years.
But a Cleveland-based economist says there are some big differences between inflation now and the 1970s.
When you talk about inflation, Cleveland is at the heart of the discussion. The Center for Inflation Research is housed at the Cleveland Fed. It’s an international think tank that studies the causes of inflation and issues recommendations for policy makers.
“One of key lessons for policy makers now is that they have a much greater appreciation and understanding of the role that inflation expectations play in the inflation process,” Rich said.
Difference #1 - the '70s were de-anchored
Rich says one of the main drivers of inflation in the '70s was the expectation that prices were going to rise, even if the underlying causes of inflation weren't there.
It’s a self-fulfilling prophecy he calls de-anchoring, price hikes based solely on expectations.
He's keeping a close eye on whether businesses believe inflation is hurting the bottom line.
“That would be a very important signal that what’s starting to happen is the high inflation readings are ingrained in people’s expectations,” Rich said.
He says this de-anchored cycle perpetuates itself as suppliers lock-in price increases based on the belief that future inflation will eat into profits.
“Looking back and learning the lessons from the '70s, especially with the role that expectations play in the inflation process is really, really important," he said.
Difference #2 - the temple is transparent
Another key difference, says Rich, is managing those expectations through greater transparency.
Rich says the Federal Reserve's cloaked communications and opaque pronouncements in the '70s were legendary. He cites William Greider's 1987 book Secrets of the Temple as an object lesson in the risks of that style.
Rich says today's Fed is different.
"There's been a very important change in the way that the Fed communicates policy and tries to be transparent, and tries to signal to financial markets and the public what it's going to do," he said.
He says that's another factor that could help ensure we don't return to the '70s inflationary cycles.
Difference #3 - COLAs have gone flat
Rich says one other difference is the structure of today’s economy compared to the '70s, especially the labor market.
“In the 70s," said Rich, "labor unions had a much bigger influence. There were COLA, or Cost Of Living Adjustment, clauses that tended to be vehicles where when price increases took place that could be passed back into wages, and the price increases, and that's much more limited now than it was before.”
Rich says today's tight labor market and wage hikes could contribute to inflation, but in many cases they're offset by increased productivity, and the ability of companies to absorb the costs within profit margins.
Rich says part of today’s high inflation is the high demand for goods by consumers flush with stimulus cash and a limited supply as a result of pandemic slowdowns and other bottlenecks.
He does expect consumption to slow and supply chains to rebound.
“We're going to see a lot of the pent-up demand and excess savings that have been accumulated during the pandemic sort of dissipate," he said.
Rich thinks demand will still grow, but will slow, in part because of reduced support from monetary policy and fiscal policy.
"We're also going to see sort of increased supply coming on board. Those factors together should moderate the rate of inflation and bring inflation down,” he said.
Rich says it’s very likely the Fed will raise interest rates next month, which have been near zero since the start of the pandemic, and begin "quantitative tightening," the opposite of quantitative easing, by selling holdings to help slow the economy.
“We're going to see reduced monetary accommodation. This isn't a secret, both in terms of potential changes in interest rates as well as changes in the balance sheet, and that's one source to restrain demand,” he said.
Robert Rich, as director of the Center for Inflation Research at the Cleveland Fed, provides research and analysis to the president of the Cleveland Fed Loretta Mester, who is a voting member on the Federal Open Market Committee, which sets interest rates for bank loans.
And granted, part of his role is to ease inflation expectations, but he did give this qualified outlook.
“We expect to see inflation moderate from its current reading toward the end of this year into next year,” he said.
Rich says the Fed will keep a close eye on January’s inflation numbers which come out later this week, plus tensions in Europe and China before making any decisions.
And, of course, he says the next COVID-19 wave could upend any economic forecast.