Commentary: 1970s Style Inflation? Not This DecadeChristopher Farrell
The specter of the 1970s is once again haunting the financial markets. With the economy running at about a 6% pace over the past nine months and oil prices tripling in about a year's time, many economists are convinced the economy is headed for a repeat of '70s-style inflation. That unhappy decade still wields a huge influence over macroeconomic policy and investor expectations.
Too bad, because the stagflation of the 1970s was unique and the lessons from it are limited. From the end of the Civil War to the coming of the Vietnam War, inflation in the U.S. averaged less than 3% during peace time. Says James W. Paulsen, chief investment strategist at Wells Capital Management: "In the perspective of the last 30 years, the 1970s receives a huge weight, but over the past 200 years, the experience of the 1970s looks like the outlier." Adds Bradford DeLong, economics professor at the University of California at Berkeley: "It is the inflation of the 1970s that is the significant exception."
OVERSTIMULATION. An unusual confluence of factors stoked inflation in the 1970s. President Lyndon Johnson overstimulated demand in the 1960s by simultaneously pursuing the Vietnam War and the Great Society. That mistake was compounded in the 1970s by Federal Reserve Board Chairman Arthur F. Burns's extremely lax monetary policy and the oil crisis engineered by OPEC. In that decade, inflation seemed unstoppable. Remember President Nixon's futile stab at wage and price controls and President Ford's Whip Inflation Now button?
Today, in contrast, government spending is remarkably restrained, and the Alan Greenspan Fed has steadfastly combated inflation pressures. Yes, oil prices are up, but the economic impact has been minimal and most oil traders expect prices to fall in coming months.
Most important, a long view of the U.S. economy throws doubt on any simple trade-off between growth and inflation. The economy grew at more than a 4% average annual rate during the 19th century, yet deflation--not inflation--was the big fear. "Some of the fastest economic growth in U.S. history occurred in the late 19th century, and prices were coming down," says Richard Sylla, economic historian at New York University. Arthur J. Rolnick, head of research at the Federal Reserve Bank of Minneapolis, agrees: "It is in the textbooks, but it is not in the data, that faster economic growth leads to inflation."
It was in the 1960s that mainstream economists developed the notion of the Non-Accelerating-Inflation Rate of Unemployment. NAIRU is said to be the rate of unemployment consistent with stable prices. In the early '90s, most economists calculated that NAIRU hovered around 6%--any rate lower than that and inflation would take off. Yet the unemployment rate has fallen from 6% in 1994 to 4% now, and inflation has come down. There may be some point at which unemployment gets so low that inflation jumps, but the connection is so tenuous that it's not useful for making economic policy.
TRAINING AND GEAR. Lower inflation and stronger growth go hand in hand. Without the distortion of inflation, investors can see supply and demand more clearly and decide how to shift their money from stagnant sectors of the economy to more promising areas. Meanwhile, the lure of higher revenues in a strong economy drives management to become more competitive by breaking down bureaucratic barriers, investing in high-tech gear, and boosting worker training. All those things lower inflation.
You can see it in the productivity numbers. For instance, productivity rose at a 3% annual rate last year, better than the 2.2% average pace of the current expansion and well above the 1.7% rate of the 1970s business cycle upturn.
Fast growth is a force for stable prices in today's economy. This isn't the 1970s.