By the time Burns was done, only about 35% of the CPI was left—and it was rising at a double-digit rate! Only at that point, in 1975, did Burns concede—far too late—that the United States had an inflation problem. The painful lesson: ignore so-called transitory factors at great peril.
Fast-forward to today. Evoking an eerie sense of déjà vu, the Fed is insisting that recent increases in the prices of food, construction materials, used cars, personal health products, gasoline, car rentals, and appliances reflect transitory factors that will quickly fade with post-pandemic normalization. Scattered labor shortages and surging home prices are supposedly also transitory. Sound familiar?
There are many more lessons from the 1970s that shed light on today’s cavalier dismissal of inflation risk. When the Fed finally tried to tackle the Great Inflation, it fixated on unit labor costs—rising wages accompanied by sagging productivity. While there are always good reasons to worry about productivity, wages appear to be largely in check; unionized labor, which, in the 1970s had sparked a vicious wage-price spiral through cost-of-living indexation, has been neutralized by global competition. But that doesn’t rule out a very different form of global cost-push inflation—namely, the confluence of supply-chain congestion (think semiconductors) and protectionist clamoring to reshore production.
But the biggest parallel may be another policy blunder. The Fed poured fuel on the Great Inflation by allowing real interest rates to plunge into negative territory in the 1970s. Today, the federal funds rate is currently more than 2.5 percentage points below the inflation rate. Now, add open-ended quantitative easing—some $120 billion per month injected into frothy financial markets—and the largest fiscal stimulus in post-World War II history. All of this is occurring precisely when a post-pandemic boom is absorbing slack capacity at an unprecedented rate. This policy gambit is in a league of its own.
For my money, today’s Fed waxes far too confidently about well-anchored inflation expectations. It also preaches the new gospel of “average inflation targeting,” convinced that it can condone above-target inflation for an unspecified period to compensate for years of coming in below target. My students would love to throw out their worst grade(s) as well!
No, this isn’t the 1970s, but there are haunting similarities that bear watching. Timothy Leary, one of the more memorable gurus of the Age of Aquarius, purportedly said, “If you remember the 1960s, you weren’t there.” That doesn’t apply to the 1970s. Sleepless nights and vivid flashbacks, complete with visions of a pipe-smoking Burns—it’s almost like being there again, but without the great music.
Stephen S. Roach, former chairman of Morgan Stanley Asia and the firm's chief economist, is a senior fellow at Yale University's Jackson Institute of Global Affairs and a senior lecturer at Yale's School of Management. He is the author of "Unbalanced: The Codependency of America and China."