Want to Know How Long This Period of High Inflation Will Last? The Answer May Lie in Our Past.
The precedent of the 70s and 80s and the Second World War is interesting to study.
“History doesn’t repeat itself but it often rhymes”
— Mark Twain
Economists around the world are currently in a dilemma: stagflation or recession?
They are still hesitating about what the future holds. Inflation is still 8.3% in April 2022 in America, and 7.5% in the Eurozone.
Just after announcing a surprise (only to some) 50 basis point hike in the Fed's key rates to fight inflation, Jerome Powell justified himself as follows:
“It's our job to make sure that inflation of this high and unpleasant nature doesn't take hold in the economy.”
Jerome Powell went on to acknowledge that the Fed is navigating at a loss right now:
“It's very complicated to make forecasts 60 or 90 days in advance. There's just so much that can happen in the economy and in the world.”
While everyone is wondering how long this period of high inflation will last, the answer may lie in our past if we refer to the Mark Twain quote I have in the preamble.
The precedent of the 70s and 80s
Much has already been written about the current galloping inflation. Its magnitude has not been seen since the late 1970s and early 1980s. In the 1970s, the United States experienced its longest period of high inflation. At that time, President Nixon decided to remove the dollar from the gold standard.
This, coupled with two spikes in oil prices, pushed the inflation rate up to 12.3% by the end of 1974. The Fed responded by raising key interest rates to 16% and then lowering them rapidly. Too quickly, so that inflation could not be contained and growth could not pick up.
In the late 1970s, Fed Chairman Paul Volcker ended this policy and kept rates high until inflation came down. This plunged the U.S. into another recession, but inflation eventually subsided, this time permanently, for the next 40 years (apart from a few temporary episodes).
Jerome Powell seems to be a great admirer of the courage shown by Paul Volcker during the stagflationary period of the 1970s in America:
“I have tremendous admiration for Volcker. He had the courage to do what he thought was the right thing.”
So will we have to wait two decades and two recessions to get back to normal inflation levels of around 2%? Probably not, because the situation today is not the same as in the 1970s and 1980s.
First of all, the labor market is doing much better, this is true in Europe, but especially in the United States where the labor market is even overheating. The economies of both regions are much stronger than they were at the time. The only point of comparison is the surge in oil prices.
We now know why inflation is high: the disruption of the supply chain, the growth in demand that followed the pandemic, and secondly, the conflict between Russia and Ukraine. A conflict that seems to be getting bogged down. We are indeed on the way to a war of attrition that will last for months, even years.
The Second World War
Here's what the White House Council of Economic Advisers wrote about World War II:
“The inflationary period following World War II is probably a better comparison for the current economic situation than the 1970s and suggests that inflation could quickly decline once supply chains are fully operational and pent-up demand stabilizes.”
Rather than a recession, we should be talking about stagflation. Probably for the next two years, say Bank of America analysts. We're in an in-between period:
“There is tentative evidence of an easing of supply chain challenges and we expect a 'two steps forward, one step back' process over the next year.”
But this fight against inflation won't last a decade, according to Bank of America analysts. Prices are expected to start falling by 2023.
Both the Fed and the ECB will be walking on eggshells, however: their goal is to curb inflation while avoiding creating a recession through too tight a policy. One might even doubt that central banks are considering the inflationary risk at the moment.
The duration of the war in Ukraine is of course difficult to predict, but as we have seen, it is not the only factor at play and is not the origin of this inflation.
Europe is nevertheless in a slightly different situation from the United States. Slower to ease, the ECB is now acknowledging that it was wrong in its estimates. It is becoming increasingly clear that the central bank will raise interest rates this year. Christine Lagarde, the head of the ECB, has just announced that the Eurozone central bank will raise rates in July 2022.
It is obvious that Europe will be more directly affected by the surge in energy prices, while an embargo on Russian oil is now only a matter of time.
As you can see, our past gives us some indications, but the reality of the coming months will have to confirm or deny this. Uncertainty therefore remains.
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