Navigating the Path Ahead: Inflation, Catalysts, and Lessons from the 1970s
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Another wave of global inflation is far from inevitable. But there are good reasons to think inflation will be structurally higher and more volatile over the next decade than the last
Are we heading for a 1970s re-run?
Inflation has only been falling for a matter of months across major economies, but the debate surrounding a possible “second wave” is well underway. Social media is littered with charts like the ones below, overlaying the recent inflation wave against the experience of the 1970s.
These charts are largely nonsense; the past is not a perfect gauge for the future, especially given the second 1970s wave can be traced back to another huge oil crisis. But central bankers have made no secret that nightmares of that period are shaping today's policy decisions. Policymakers are telling us they plan to keep rates at these elevated levels for quite some time.
Inflation: The 1970s versus today
Rewind 50 years and not only did inflation fail to return to prior lows in either the US or the UK after the initial 1974 spike, but both countries saw at least one additional spike over subsequent years. Germany fared better, but wages did respond to the second oil crisis, helping to push inflation up again.
The lesson was that for a second wave to really take off, you need a catalyst and an economic environment ripe for inflation to take hold.
The twin oil price shocks in the 1970s fell on a US economy that was already running hot, a byproduct of persistent US trade and fiscal deficits that grew through the 1960s, aided by the often loose monetary policy of then-Federal Reserve Chair Arthur Burns. That excess demand helped end the Bretton Woods system of fixed currencies and the US dollar lost a quarter of its value between 1970 and mid-1973 as the agreement collapsed, amplifying the hit from higher energy costs. And all of this fell upon an economy that was much more manufacturing-centric than it is today, and it was also heavily unionised. Wage growth typically kept pace with inflation.
Back to today, the economy looks very different. But we think there are valuable lessons, and these are our main conclusions:
- A second wave isn’t inevitable, but we think there are good reasons to expect inflation to be both structurally higher and more volatile over the next decade. The same is true for central bank rates.
- The US is less vulnerable to energy shocks than in the 1970s, but further gas price spikes are possible, and that could prompt renewed waves of eurozone inflation. With prices still well above 2021 levels, a shock would likely be smaller. However, a second energy price shock could lead to more pronounced feedback between eurozone wages and inflation.
- Shortages of metals, be it due to lack of investment or geopolitics, are a growing inflation risk, especially amid the green transition. This probably wouldn’t generate a 2022-style inflation shock by itself, but it is likely to be a source of constant price pressure in future years. Extreme weather is also likely to make food prices more volatile.
- Unionisation is less widespread than in the 1970s, but there are signs that worker power is increasing amid structural worker shortages. The ability of workers to protect real wages in future inflation shocks is set to grow.
- Tighter fiscal and monetary policy should act as a brake on inflation over the short-to-medium-term. Interest rates aren’t likely to return to pre-Covid lows in the foreseeable future, and quantitative easing is unlikely to be used as an economic bazooka. But Covid and the Ukraine war have lowered the bar to big government tax/spending intervention in future crises.
