Is it 1976?

In terms of inflation and interest rates, I think so.

By 1976, inflation was 5.74 percent. Although the interest rate in November, at 4.75 percent, was higher than in 1964, it was lower than the rate of inflation. In that sense, the interest rate was low

That was when inflation was poised to take off.

Every time I hear someone talk about “temporary supply” shortages causing inflation I want to grab them by the collar and shake them. If the government hasn’t gone wild with deficit spending, then a price increase in a supply-constrained sector will be offset by a price decline somewhere else.

21 thoughts on “Is it 1976?

  1. Unless they cover it up, the OER should start printing very high inflation after the time lag just in time to offset any SnapBack in things like used cars.

    Of course the fox guards the henhouse on the OER.

    • The OER explanation might be more innocuous. The number is calculated from a survey that asks you how much you might pay in rent to live in your own house. I suspect for most people that this answer is a function of whatever their current mortgage and property tax expense is. Why would anyone say that they would pay more in rent than they do in mortgage/tax/maintenance/insurance to live in the same house? Their mortgage and property tax values in turn are a function of household income, with lags. As incomes increase, people tend to buy more house broadly defined (i.e. bigger homes, homes with more land, similar sized or smaller homes but made with more luxurious materials in nicer neighborhoods, etc.)

      https://www.pennmutualam.com/market-insights-news/blogs/chart-of-the-week/2021-02-25-owners-equivalent-rent-and-price-stability

      –“Why has OER exhibited such stability versus market-based measures of shelter costs? Economists have observed that owner-occupied rental estimates tend to be “sticky” relative to market-based rental costs. Homeowners tend to underestimate rent appreciation during expansionary periods and overestimate it during recessionary periods. Research by the Cleveland Federal Reserve suggests the best predictor for OER inflation is recent OER inflation. In other words, OER momentum is a more useful predictor for future OER measures than home price appreciation, vacancy rates, interest rates or unemployment.”–

  2. I don’t know whether this is right or wrong but credit to Arnold for making a real prediction that will either be proved right or wrong.

    Temporary supply shortages and longer term inflation inflation well above 2% but well below the late 70’s seem like one possible scenario to me.

    • “prediction that will either be proved right or wrong”

      Depends on whether there is a specific time period for the prediction, i.e., what does it mean to be “1976” or that inflation “is poised to take off”? Does that mean Arnold is predicting high interest rates and rising inflation within the next four years (1976-1980)? If so, then the prediction is indeed testable. Without a specific time period though, predictions are never wrong, just early.

      • I take it to mean that the next few years after this one will have inflation comparable to the next few years after 1976. I agree that real predictions need to be time constrained, but unless I’m misunderstanding what Arnold means, this one is.

  3. The entire world’s supply chain has been negatively impacted by COVID. The political response was more severe in other countries. Despite this, YoY Core CPI in places like the UK, Euro Area, Switzerland and Japan all remain near their 2019 levels, whereas in the U.S. YoY Core CPI is double the 2019 rate. To the degree shortages have caused price spikes in certain commodities overseas, other prices must have fallen, as Arnold says.

    At least in the US, the growth of Core CPI recently has been artificially held down by OER, a phantom price which no one sees in real life, which has allegedly been growing 0.2%-0.3% per month recently, vs. 0.7%-0.9% per month for the Core CPI as a whole, and probably something closer to 1.0-1.5% monthly in the actual housing market.

  4. If the government hasn’t gone wild with deficit spending, then a price increase in a supply-constrained sector will be offset by a price decline somewhere else.—ASK

    Please don’t shake me!

    I always wondered if this really works in the modern economy.

    Also, you can get less velocity no?

    I am cowering in the bushes…but…Q2 compensation up 3.1% YOY.
    If you have a mere 1% increase in productivity, then you get rather modest 2% unit labor cost push….

    I think this may be the peak…3% inflation and tight labor markets? I hope that lasts forever….

    • The true question is whether compensation remains up only 3.1% YoY. I think there’s a significant risk that by early next year, that number will be 5%+.

      The labor shortage in much of the lower end of the economy remains. Help wanted signs are everywhere, service is terrible at restaurants and some restaurants are occasionally closed for lack of help or require owners to wait tables. At grocery stores, many checkout aisles are unattended. The natural way to remediate these shortages will be pay hikes which will be passed through to consumers.

      The number of unfilled positions has lingered near record highs.

      People are aware that prices have gone up a lot, and I’m expecting many will want sizable increases in compensation by the next pay cycle or they’ll consider a new job.

      The corporation I work for has annual pay cycles. For the first time in my experience going back to the mid 2000s, there is now a midyear effort to target raises and retention bonuses to combat turnover, with more people getting these raises/bonuses than not. Though not final, the amounts currently discussed represent a 5.2% increase in my team’s cash compensation, on top of raises which went through in March. These are well compensated white collar workers who aren’t affected by things like high unemployment insurance payments.

      • Interesting.

        BTW, in the four years 1976 to 1979, the real US GDP increased by 20%.

        A 20% expansion in real GDP in four years is not a bad result.

        • It’s not a bad result in isolation, but we have to consider the overall historical context. I wasn’t around in the late 1970s or early 1980s, but the people who lived during that time usually don’t recount those years as particularly prosperous.

          From 1975Q4 to 1979Q4, real GDP did rise 18.3% or 4.3% annually.

          In the late 1970s, baby boomers and women were surging into the labor force, with the labor force increasing 3.0% annually, and employment rose 3.6% per year, as the economy recovered from the severe 1973-1975 recession. Thus, GDP per person rose at just 0.7% per year.

          Unemployment fell from 8.2% at the end of 1975 to a still elevated 6.0% at the end of 1979, with a severe double dip recession necessary to kill the inflation pushing unemployment to nearly 11%.

          Real median wages (1982-1984 dollars) for men employed full time year round fell from $25,194 in 1973 to $23,714 in 1976, $23,435 in 1979, and $21,841 by 1982. By the peak of the next business cycle in 1989, wages rose just a smidge to $22,041, 12.5% below 1973 levels. While the full time wages of women rose during that 16 year period, they only rose slightly, by 6.1%. On net, a family which had two earners working full time and earning the median wage would have seen overall real income fall 5.7% between 1973 and 1989.

          https://babel.hathitrust.org/cgi/pt?id=uiug.30112026498003&view=1up&seq=48

  5. “…a price increase in a supply-constrained sector will be offset by a price decline somewhere else.”

    True. But that causes recessions, as we adapt to new PSST. The 1970s oil shocks are an example. The Fed’s monetary stimulus has allowed prices to increase in supply-constrained sectors, without your postulated nominal price declines in other sectors.

    The money creation worked, brilliantly. We were all afraid of an unprecedented recession, which didn’t happen.

    Now the question is: can the Fed engineer a soft landing? If they let inflation get too high and/or run too long, they will have to slam on the brakes, which will cause a recession.

    Arnold, you may well be right. Any chance you could re-post any comments you had about QE, QE II, and the $800 billion stimulus from 2009? Your credibility is enhanced if, at that time, you were writing that those stimuli would not cause inflation.

    • I am a little confused: are you claiming there has not been a recession since 2019? It sounds a bit like you are, but that is hard to believe given the immense contraction that happened over the last year and a half, so I am assuming I misunderstand.

      • I am saying we expected the recession to be FAR worse than it actually was.

        A decent proxy for expectations of recession was the stock market collapse in late February – March of 2020.

  6. Arnold’s model shares some elements with Scott Sumner’s and other monetarists (not to be confused with Modern Monetary Theorists) in that Arnold seems to agree that interest rates often reflect *past* looseness or tightness rather than the current stance of monetary policy. Hence, “in 1980 interest rates caught up with inflation”, i.e., the high interest rates of 1980 reflected loose policy of 1976-1980.

    One way Arnold’s model seems to be unique is that he seems to implicitly set the natural (nominal) interest rate at the current inflation rate: “[1976 interest rate] was lower than the rate of inflation. In that sense, the interest rate was low”, “interest rates remained at or below the inflation rate in the early 1970s…upward pressure on inflation persisted”, “in 1980 interest rates caught up with inflation, and the higher interest rates eventually caused inflation to subside”. Does Arnold believe that negative short-term real rates are always inflationary and positive short-term real rates are deflationary? If so, why? If not, what are the exceptions?

    The other claim that catches my attention: “If the government hasn’t gone wild with deficit spending, then a price increase in a supply-constrained sector will be offset by a price decline somewhere else.” Is Arnold’s claim here that, absent “wild” government deficits, the short-term AD curve is horizontal (so that a shift of AS leads to no “temporary” inflation)? If so, that’s not something that I have heard before and I would like to hear Arnold give more explanation as to why. I would understand an argument that, if total spending (i.e. NGDP) increases, then that’s a shift in AD so that the corresponding inflation shouldn’t be attributed to “temporary supply” constraints. However, that seems to be different from Arnold’s claim.

  7. 1976? Let’s count the ways things were different:

    -Strong labor unions that had built in expectations of annual pay increases
    -No containerization, no just-in-time inventory systems, fewer complicated supply chains
    -No Japan or China as significant export economies
    -Arthur Burns
    -A sclerotic, decrepit corporate system that was cruising on the momentum of post-war capital investments and marching to its doom arm-in-arm with the afore mentioned labor unions
    -Vietnam hangover

    • Yeah, wouldn’t we need to see the dollar depreciating against other currencies to get inflation in goods, because so many are imported?

      • There are a lot of differences, that is true, and some of those differences weigh against inflation. On the other side of the ledger, the only historical equivalent to 2020-2021 fiscal conditions can be found during World War 2, and the labor market ‘feels’ much tighter now than it did with 3.5% unemployment two years ago. I don’t have a firm view of what will happen next. If I had to put my money on it, I would be in the temporary inflation camp, but with only 60-70% confidence. I’m not convinced that the necessary monetary/fiscal actions needed to keep inflation from becoming durable are politically acceptable. The only question is how much power workers have in the next 6 months to force employers to offer wages that match/exceed 2021 inflation rates. If they have that power, inflation will become durable barring contractionary fiscal/monetary policy. A 2022 or 2023 recession will likely be politically unacceptable for the Democratic party, which now largely controls the government.

        With respect to imported goods, they represent only 12% of the US economy and much of the value added of those goods comes from designing and/or selling those goods in the U.S. For example, Apple might import an iPhone for $400 and then turn around and sell it for $1,099. Even though it is made entirely in China, it adds $699 to U.S. GDP. If the cost of employing marketers, engineers, designers, genius bar team members, etc rises at 5-6% a year rather than 2-3% a year, iPhone prices will have to rise eventually to maintain margins, even if the cost of the imported phone stays constant. Also, if elevated inflation rates linger on, that may lead to pressure on the dollar which would force up import prices.

  8. What were passbook savings accounts paying in 1976?

    I can get 0.5% from a credit card bank today. Nothing from a “savings account.”

  9. Interest rates are … the cost of money.
    In 1976, as I and other baby boomers were going to college, money and wealth was scarce. When money is scarce, and likely wealth, their price goes up.

    A huge amount of US and OECD wealth and money was quickly transferred to OPEC starting in 1973. As Arnold says:
    “a price increase in a supply-constrained sector will be offset by a price decline somewhere else.”
    Tho he didn’t quite say “real prices”.
    Oil prices, and all transport prices, increased faster than inflation – but inflation made other nominal prices increase, yet slower than oil. Which hides the price and wage real relative declines.

    Plus, the HUGE increase in demand from young adult baby boomers.
    The Depression didn’t prepare economists for 70s stagflation, which didn’t prepare for “information age”, the post-USSR “peace dividend”, the 1996 “irrational exuberance” of the dot.com bubble, which burst not months but years later, which didn’t prepare for the house bubble & crash and TARP bailout for the irresponsible rich – and today’s MMT with the new stock market bubble.

    In the 70s, supply was “constrained” enough that labor could call a strike and get more cash. Not today. All supply constraints, including of good-to-great vaccines against an escaped bio-weapon lab virus, really are “temporary” – less than a year. IF the politicians allow the market producers to produce.

    We’ve been having a decade of high stock-price “inflation” – successful tech company stock prices have been booming. Not so much, tho not nothing, in the prices of Big Macs or milk.
    Good 2017 article calling for higher interest rates due to price increases higher than “CPI”: https://seekingalpha.com/article/4119246-big-mac-index-may-be-telling-truth-inflation

    All of the elites all over the world are getting richer, faster, than US inflation. So who’s going to stop the Fed from going up to 200% GNP in national debt?
    Or 400%? If Apple can be worth $2,000,000,000,000, why not $4 trillion? or 8?

    What else are the rich folk with investible cash going to invest in?
    Solar? Batteries? China? Africa? (again?) Sub-prime mortgages? (again???)
    A space race to Mars? (Go Elon! Both Branson & Bezos have now made it to space, once)

    Nixon ended Bretton Woods gold-USD relationship in early 70s.Globalization means a new factory can be built anywhere – Capital Expenditures (US) were way up 2017, ’18, ’19, but down ’20.

    I’m not sure what we will see in the next 4 years, (interest rate, inflation, unemployment, real wages) but am very, very confident it won’t look like any 4 years from the 70s. 60% guess it’s a lot like the last 4 years, more so than any other 4 years in history.

    • Interest rates are … the cost of credit, the cost of loanable funds.

      The price level is the cost of money.

Comments are closed.