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THE BOTTOM LINE

Will inflation kill the economy?

Washington

INFLATION is back. What do we do about it? For starters: Don't ignore it.

The latest consumer price index (CPI) - the government's best-known inflation indicator - reported a 2.9 per cent increase from July 2017. The last time that the year-over-year gain was higher was in December 2011. Though hardly a cause for panic, it suggests intensifying price and wage pressures in an economy straining at its productive capacity. The Trump administration and its critics should be watching closely.

Consider this: rents rose 3.6 per cent from a year earlier; hospital prices increased 4.6 per cent, petrol 25 per cent and eating out 2.8 per cent. Still, some price increases were small or non-existent, offsetting some gains. New vehicle prices edged up a mere 0.2 per cent, electricity was down 0.8 per cent and airline fares dropped 4.1 per cent.

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The reason for paying attention to inflation is that once it accelerates, it is hard to stop. That was what happened in the 1960s and 1970s. The quest to reduce unemployment led to easy money that spawned double-digit inflation. CPI inflation went from about one per cent in 1960 to 6 per cent in 1969, and to 13 per cent in 1979. It was crushed only in the early 1980s when the Federal Reserve raised interest rates sharply.

This searing episode taught many important lessons, but we are in danger of forgetting them because a majority of today's Americans did not experience the high inflation. (In 2017, the US population was 326 million; roughly two-thirds were not alive or were too young to understand the high inflation.) Here are four significant takeaways:

  • Don't buy into the argument - made often in the late 1960s and early 1970s - that a "little bit more inflation" won't be harmful and will help reduce unemployment. Superficially, this sometimes seemed true, but "a little bit more inflation" led to "a little bit more" and then "a little bit more". Soon, there was a lot of inflation, which created an inflationary psychology. Expecting more inflation, companies and workers tried to get ahead of the process by preemptively raising wages and prices.
  • High inflation is ultimately harmful to the economy, because it subverts both stability and growth. From 1969 to 1982, there were four recessions (1969-70, 1973-75, 1980 and 1981-82) as the Federal Reserve vacillated between fighting inflation and joblessness. Both got worse. Monthly unemployment peaked at 10.8 per cent in 1982. Even before adjusting for inflation, the stock market stagnated from the mid-1960s to the early 1980s.
  • People hated high inflation. For most of the 1970s, Americans listed high inflation as the nation's No 1 problem. High and rising inflation created enormous uncertainty. People had more trouble planning for the future. They did not know whether their incomes would keep up with their expenses; there was (or so it seemed) a random redistribution of income among groups, depending more on luck or political clout than any economic logic. In a post-election interview with journalist Theodore White, President Jimmy Carter singled out inflation as a crucial factor in his defeat.
  • Productivity matters. As is now understood, high productivity growth - efficiency - makes it easier for firms to avoid raising prices. Gains in efficiency cut costs; the savings can be passed along to workers in higher wages, shareholders in higher profits or consumers in lower prices. Prices need not be boosted. Unfortunately, US productivity growth languished in the 1970s; the same is true today. This makes it harder to contain inflation.

Since late 2015, the Fed has been gradually raising interest rates in hope of heading off future inflation increases. This focus is surely justified. But it is not clear whether the Fed's moves amount to too little too late, or too much too soon. The Fed's forecasting record is at best spotty. If we get this wrong, it could kill the economy. THE WASHINGTON POST WRITERS GROUP