Today’s inflation and the Great Inflation of the 1970s: Similarities and differences

Jongrim Ha, M. Ayhan Kose and Franziska Ohnsorge in this voxeu article compares today’s inflation with the Great Inflation of the 1970s:

There are important differences between the current situation and the 1970s. First, at least thus far, the magnitude of commodity price jumps has been smaller than in the 1970s. In the wake of major oil shocks, oil prices quadrupled in 1973-74 and doubled in 1979-80. The combination of high inflation with weak economic growth, fuelled by repeated supply shocks, gave rise to the phenomenon of ‘stagflation’. Today, oil prices are, in real terms, still only around two-thirds of those in 1980 or 2008 (Figure 2b). 

Second, there has been a paradigm shift in monetary policy frameworks since the 1970s. In the 1970s, instead of today’s typically primary focus on inflation, central bank mandates incorporated multiple competing objectives, including for output and employment, as well as for price stability. Most central banks in advanced economies, freed in 1971 from the constraints of the Bretton Woods system of fixed exchange rates, aimed to support economic activity with monetary expansion, without realising that potential output growth had started to slow (de Long 1997). Policymakers were inclined to attribute rising inflation to special factors, and underestimated the pervasive and lasting impact of excess aggregate demand pressures (Blinder 1982). 

This ‘passive’ monetary policy stance resulted in a multi-decade period of rising and mostly elevated inflation. Global median inflation started the 1960s at a low 1.5% but then trended up rapidly, in the range of 1.5–4.7% through the 1960s. In 1970, it reached 5.5% and then continued to trend up in a range from 5.5–14.4% through the 1970s before culminating at 14% in 1980. In comparison, today’s global inflation is only recently above pre-pandemic levels, since mid-2021 (at 5% on average in 2021–22 and 7% in March 2022). That said, model forecasts and consensus expectations suggest that global inflation could rise to almost 10% later this year before it starts declining. 

In contrast, central banks in advanced economies now have clear mandates for price stability, expressed as an explicit inflation target. They have adopted transparent operating procedures, announcing and justifying their settings for the policy rate. Over the past three decades, they have established a credible track record of achieving their inflation targets (Bordo et al. 2007, Eichengreen 2022).

As a result of such improvements in policy frameworks and better anchored inflation expectations, inflation – in particular, core inflation – has become much less sensitive to inflation shocks (Ha et al. 2022, Figure 2c). In addition, for now, inflation increases have been concentrated narrowly in a few energy-intensive and pandemic-affected sectors, although there are signs that inflation pressures may have been broadening recently. This stands in contrast to 1979–80, when the inflation acceleration was broad-based, with similarly high inflation rates cutting across virtually all sectors (Figure 2d) Hence, inflation in some sectors is expected to decline once supply disruptions ease and commodity prices stabilise (Borio et al. 2022, Ilzetzki 2022).

 

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