The Origins of the Great Inflation

The first post which began to tangentially broach on this subject was my Bretton Woods, Chaos, Price Stability. Read that post as well. The best graph, perhaps, to explain the origins of the Great Inflation is this one:

FireShot Screen Capture #003 - 'FRED Graph - FRED - St_ Louis Fed' - research_stlouisfed_org_fred2_graph__g=1sI7

The best thing to do with such charts is to start at the beginning, then reveal them slowly.

The first portion of the Great Inflation began in the late 1960s and early 1970s, when NGDP was at first growing at a fairly fast pace, then, during the near-recession of 1967 and the recession of 1970, began to slow down. Yet, the rate of inflation continued rising into the recession of 1970. At the time, the goods and services rising in price the fastest were shelter, services, and food. Energy inflation was near-nonexistent at the time. Throughout the course of 1971, however, inflation moderated, even before Nixon’s price controls. In the first quarter of 1973, year-over year NGDP growth per labor force rose to a high not seen in over a dozen years. Yet, inflation was contained, except in food, where prices spiked due to poor harvests. Food and energy prices continued spiking over the course of 1973, with food price inflation in August being over 19% and that in energy over 7%. Nothing extraordinary was happening anywhere outside these commodities. After August, services and shelter began spiking. The last months of the year experienced the second-largest energy shock in mankind’s history. After 1973, even while NGDP growth less labor force growth fell to below 5%, even commodities less food and energy commodities started spiking. The worst phase of the Great Inflation was on. This great supply-side inflation led monetary policymakers to be content with strongly above-previous-trend NGDP growth. This was so in Portugal, Spain, Greece, Italy, Britain, and Canada to a much greater extent than the U.S., while Japan and Germany moderated monetary policy to prevent such a great inflation from happening again. After 1975, U.S. NGDP/labor force growth never went below 6% until 1980. In 1976, it went over 10%, and in 1978, over 11%. In the U.S., inflation in all sectors fell from 1975 to 1976. In 1977, it began rising again, led by shelter and food. In 1979, the largest oil shock ever hit. Due to a moderation in NGDP growth, the economy slumped in 1980, despite the oil shock taking place a year earlier. In 1979, even consumer commodities less food and energy commodities inflation was over 6%. Supply was tight, nominal growth was high.

However, things were about to change for the better drastically. Between mid-1980 and mid-1981, a curious thing happened: while inflation declined strongly in all major areas, NGDP growth per labor force skyrocketed from under 6% to over 12.5%. The back of inflation had begun to be broken, not by monetary policy, but by the alleviation of supply constraints.

During 1981-1982, as you know, inflation and NGDP growth all fell rapidly in all areas, with NGDP growth, understandably, falling faster than inflation. This is from where the common half-true mythology of Volcker breaking the back of inflation by repressing demand came from. Yet, after this strong demand shock, Volcker allowed NGDP per labor force to rise back to its 1975-1980 trend. Yet, this strong positive AD shock was translated, not, as in the 1970s, largely into inflation, but largely into real growth. In Q1 of 1984, while the inflation rate of all major sectors except energy was around four or five percent, NGDP per labor force growth was over 10.5%. This was an extraordinary achievement, partly resulting from the re-hiring of millions of those workers fired in 1981-1982, but also resulting in part from the beginning of a new era growth in Real GDP per worker. This era would continue until roughly 2005.

Screenshot (143)
Screenshot (144)

Another curiosity occurred after the end of the early 1980s recovery: nondurable goods inflation, and even durable goods inflation, became increasingly uncorrelated with services inflation, which began to be surprisingly stable over the decades, only suffering a major shock during the Great Recession. This newfound lack of correlation was especially clear by the 2000s, where massive energy inflation failed to make a dent on services inflation. This likely resulted from the decreasing importance of oil and food in the economy, as well as the newly increasing importance of services.
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Author: pithom

An atheist with an interest in the history of the ancient Near East. Author of the Against Jebel al-Lawz Wordpress blog.

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