November 22, 2015
NPR had a piece on the horrible inflation of the 1970s and how the country was rescued by the herioics of Paul Volcker who was Fed chair at the time. The piece raises several points that could use a bit more context and leaves out some important information.
First and most importantly, the piece implies a world that did not exist. It begins with a discussion of a speech by President Gerald Ford in 1974. It told listeners:
“Inflation was the silent thief, and every year it got worse. Inflation got worse. It went from 10 percent to 11 percent to 12 percent. It wasn’t clear exactly why and no one could agree on a simple way to fix it.”
Neither part of this story is especially true. Inflation was hardly silent. It was widely reported, so people did know about it. Nor was it obviously a thief. Many, perhaps most, wage contracts were indexed to inflation, which meant that wages rose more or less in step with prices. While this was not true for everyone, a substantial segment of the population was able to insulate itself from the effects of inflation. This is one of the factors that made it harder to contain inflation.
It is also not true that no one knew how to fix it. Higher unemployment reduced workers’ bargaining power and lowered demand in the economy. This slowed inflation. In fact, the skipping from Gerald Ford to Paul Volcker, mispresents the actual course of inflation over this period. Inflation did in fact come down. After peaking at 10.4 percent in 1974, it fell back to 5.5 percent in 1976 before it started to rise again. The main factor bringing inflation down was a steep recession in 1974–1975, so the method for bringing inflation under control was not quite as difficult to figure out as the piece implies.
Then we get this account of the period from NYU economist Bill Silber:
“SILBER: It sort of took over your life. You had to worry about buying things before they went up in price. Every time you turned around you’d say, well, I mean, I better buy it now rather than later and of course that’s the process, which makes the inflation accelerate because everybody starts thinking that way. Just buy something because you know if you buy it now you’re better off than if you wait.
“KESTENBAUM: Do you remember that happening with you? Did you buy anything for that reason?
“SILBER: I think I bought a house.
“KESTENBAUM: People buying houses just because they think they’ll be more expensive the next year – that is not good. …”
Perhaps inflation took over Mr. Silber’s life, but this is not likely true for many other people. House price inflation peaked at 16.3 percent in the year from February of 1978 to February of 1979. This is not good, but there are two points worth noting. First, it was already on its way down by the time our hero, Paul Volcker, enters the stage in the fall of 1979. On a year over year basis the rate of house price inflation was down to 14.8 percent and if we annualize the rate for the immediate three months before Volcker took the job it was down to 11.8 percent.
The other point is that we have seen comparable rates of house price increases more recently. For example, in the year from August 2004 to August 2005 house prices rose by 14.5 percent. Did it take over your life?
The other point worth noting here is that most prices were not rising anywhere near this fast. For example, car prices were rising at a 7.5 percent annual rate when Volcker took the job. This meant that if you were considering buying a car for $20,000 (in today’s dollars) and waited a month, it would cost you $150 more. Clothes were rising at less than a 4.0 percent rate. This meant that it would cost you $1.30 if you put off buying that $400 suit for a month. Waiting a month on a $20 shirt would cost you 7 cents. This was not Weimar Germany where inflation was reaching the point people could not do ordinary business.
In addition to the misrepresentations, there is an extremely important part of the story left out of the discussion in this piece. Oil prices quadrupled in the early 1970s as OPEC first flexed its muscle as a cartel. They quadrupled again in the late 1970s as the Iranian revolution took the country’s production, then the world’s second largest exporter, off the market. At the time the economy was both more dependent on oil and less flexible than it is today.
These price increases played a huge role in driving up inflation as there was no easy way for the economy to deal with this jolt. The impact of the oil price rises was widely known and discussed at the time so there is nothing mysterious in this story. Oil prices plunged in the 1980s as increased supply and reduced demand, both due to the recession and conservation efforts, put downward pressure on prices. Lower oil prices would have dampened inflation with or without Paul Volcker’s magic.
The other important piece of the inflation puzzle left out off this discussion is that official consumer price index seriously overstated the rate of inflation at the time, with the gap approaching two full percentage points in 1978 and 1979. This mattered both because many contracts were legally tied to the rate of inflation and also because many workers would likely have seen the official CPI as setting a target for wage increases. This overstatement disappeared in the 1980s, first because the factors driving it went into reverse, and second because the Bureau of Labor Statistics changed its methodology. This also had nothing to do with Paul Volcker’s magic.
In sum, the inflation in the 1970s was nowhere near as debilitating as this piece implies. It was not in the least mysterious and would likely have come down even without the magic of Paul Volcker. The Volcker recession destroyed the lives of millions of workers and their children. It is very much an open question as to whether a more rapid reduction in the rate of inflation was worth this pain.
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