John Rapley is a political economist at the University of Cambridge and the author of Twilight of the Money Gods: Economics as a Religion and How It all Went Wrong.
People who lived through the 1970s, that bell-bottomed, mirror-balled, platform-shoed time, often recall it as the decade that taste forgot. But there was one good thing about those years: affordable homes. With the ratio of average prices to income much lower than today, a house in Brampton, Ont., for instance, which today might set you back a million bucks would have cost half that then in today’s dollars. However, there was one small catch: It came with a mortgage rate of 18 per cent.
That’s because the seventies was also the era of “stagflation,” the dreaded mix of recessions and high inflation. And it all stemmed from a bold experiment with cheap money that went awry.
Until 1970, the head of the Federal Reserve had been William McChesney Martin, the U.S. central bank’s longest-serving chairman. Mr. Martin had once famously described the role of a central banker as the chaperone who removes the punch bowl just as the party gets going. So, when inflation started rising in the late 1960s off the bubbling U.S. economy, he wanted to boost interest rates to nudge Americans to spend less and save more.
But president Richard Nixon, who faced re-election in 1972, wanted to crank up the volume of the party. He fired Mr. Martin and installed a more compliant chair. The Fed then loosened the purse strings, keeping interest rates low even as prices rose until, ultimately, inflation peaked at 12 per cent. A new chair, Paul Volcker, then came on the scene to shut down the party. In 1979, he announced his “Saturday Night Special,” raising interest rates to the roof. The rest is history. After a punishing recession, inflation fell to earth and has remained there ever since. Today, central bankers consider it all but extinct.
In recent months, though, inflation reports have revealed sharp spikes in prices reminiscent of the 1970s. Central bankers aren’t worried, though, insisting the inflation will prove “transitory.” In that vein, like a party planner who keeps spiking the punch, Bank of Canada deputy governor Timothy Lane recently said the recent jump in the country’s inflation rate “will not persist beyond the next few months.” And his reasoning is easy to get. As the economy reopens and demand booms, some temporary shortages have developed, driving up prices on everything from fuel and lumber to labour. But that will just prod unemployed people back into the job market and prompt suppliers to work out the bottlenecks in their supply chains, all while producers ramp up production to chase higher returns. A short bout of inflation will thus drag the economy out of the doldrums, at which point prices will settle back down.
But might this all be just a bit too glib? After all, if the seventies was a period of cheap money, it was nothing compared with our day. Over the past decade, and particularly since the start of the pandemic, central banks have released a tidal wave of money by slashing interest rates and buying bonds – practically giving money to both governments and businesses. Last year alone, the Bank of Canada injected several hundred billion new dollars into the economy this way. The Fed upped the ante and made it a cool few trillion. That’s not topping up the punch bowl. It’s more like raining drink on the party with a firehose on full.
That’s why some critics allege that central bankers are behaving less like prudent chaperones and more like the mayor in Jaws, who ignores the warnings about a shark in order to keep the beaches open for the Fourth of July. Prominent economists such as Larry Summers and Nouriel Roubini say there’s way too much money going around. During the prolonged lockdowns, this money flowed into meme stocks, cryptocurrencies and real estate. But now, with economies reopening, it’ll find its way back into the real economy, with deleterious effects.
In fairness, though, theirs is not a majority opinion – at least not yet. From tweedy Keynesians such as Paul Krugman to the trendy new theorists of the so-called Modern Monetary school, many economists back the bankers, telling us to relax. They point out that the world has changed since the 1970s. Take oil prices, for instance. Even if they’re rising as sharply today as they did then, they haven’t yet tipped the needle much on inflation. That’s because while we in the West consume far more than we did in the seventies, the amount of energy powering each unit of that consumption has dropped a lot. Anyone who was around back then will recall how hot a television could get after an evening’s viewing. Compare that to your tablet after several hours of streaming.
Or take trade unions. They’re weaker than they were in the seventies, which means short-term price increases won’t necessarily translate into the sort of wage gains that could keep prices constantly rising. On the face of it, latent inflationary pressures just aren’t what they were in the 1970s.
Nevertheless, if past behaviour remains the most reliable guide to future behaviour, we may want to err on the side of caution here. Because not only is this not the seventies, it’s unlike any other era in our modern history. The fact is, we have no precedent for our current situation. An oil shock is not a global pandemic. It certainly didn’t upend the world economy the way COVID-19 did. And there’s plenty of reason to believe the world into which we are emerging will differ a lot from the one we left.
For instance, supply-chain bottlenecks could have knock-on effects, taking years rather than months to sort out. Meanwhile, the surge in house prices, fuelled by the flood of cheap money, could translate into rent increases, which would make inflation more “sticky.” And the expected flood of unemployed people re-entering the job market as economies reopen may not happen. Despite persistent joblessness, employers complain they’re struggling to fill vacancies. It could be that some workers spent the pandemic re-evaluating their lives and have decided not to re-enter the work force. Or that the persistence of COVID-19 is forcing some workers to stay away – a big problem in Britain, for one. Or that reduced immigration and border closings have limited the supply of workers. Or even that pandemic-induced digitalization has created skills mismatches – if the shift to online shopping that was forced upon us remains permanent, we may have too many shop attendants and too few IT specialists.
Rising labour costs could be what tips the balance of price increases from transitory to permanent. There is indeed evidence that rising wages are beginning to produce higher prices, at least in some places. All the same, we’ve yet to get reports of massive leaps in labour costs. So let’s split the difference between the two sides of the inflation debate and suppose the inflation pressures turn out to be permanent rather than transitory but still pretty modest – say, nudging upwards from less than 2 per cent to maybe 3 per cent. And if that inflation results from higher wages, after decades of stagnant real incomes, that would be a plus. Not a bad outcome, really.
Except that even such a modest bump in prices could cause real problems for some people. One effect of the ultracheap credit of the past decade is that Western societies have taken on a mountain of debt. In Canada, businesses and households together now owe three times the country’s annual output. Add in the debt of the federal and provincial governments and that rises to more than four times. Just imagine what even a small rise in interest rates would do. Not only would the higher debt payments take a noticeable bite out of GDP, but asset values, including the houses Canadians have been buying with cheap mortgages, could fall. Millions might see their cost of living rise just as their wealth declines.
The economy would probably sail through – and possibly even benefit from this reallocation of money to more productive uses. So in that sense, the relaxed attitude of central bankers is understandable. But they may still want to prepare people for what could lie ahead. Because for many Canadians, it might feel less like a punch bowl being removed and more like the lights coming on and someone on the PA system yelling at everyone to go home.
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