1947, 1970s, 2008: Inflation experts look back into history for lessons

Central bankers know how to raise benchmark interest rates, but they have less experience in calibrating the exit from quantitative easing.

Topics

Inflation | US Federal Reserve | Bank of England

From spikes in Americans’ cost of living to surging factory-gate prices in China, inflation is stirring in all corners of the globe. Monetary chieftains, meanwhile, are sticking to their guns, stressing the spurt is temporary. Investors trying to make sense of this are scouring history for the right analogies, and policy makers are scrutinizing the record for the best–and worst–approaches. Pick your era: the 1970s, the aftermath of Lehman Brothers Holdings Inc.’s collapse or even the years after World War II. All are being parsed for lessons.

A lot hinges on getting the historical context right. Let inflation go too far, and central banks risk a downturn if they have to rein in activity too forcefully. Crack down too soon, and miss the chance to see whether the increases are a kind of false flag, the product of a natural bounce from a bruising pandemic-induced slump. Authorities in the biggest economies say they think price rises are temporary and that inflation will stabilize at about their preferred level, generally around 2%. There’s not an awful lot of daylight between Federal Reserve Chair Jerome Powell, whose favorite word lately appears to be “transitory” and People’s Bank of China Governor Yi Gang, who said Thursday, “We must not lower our guard regarding inflation and deflation pressures from all sides.” The recent surge in producer prices partly reflects comparisons with low prices a year ago, he said.

The mediocrity of inflation in the past decade has shaped this fairly patient stance. U.S. Treasury Secretary Janet Yellen, who led the Fed for four years, is sympathetic to this view, having battled disinflation herself. She told Bloomberg News last weekend that a bit more inflation would be a plus after years of lowball numbers. On the fiscal side, now Yellen’s bailiwick, there’s little political appetite to rein in spending, as there was in the early years of Ronald Reagan’s presidency or after 2010, when Republicans made big gains in Congress. Former Fed leader Paul Volcker’s assault on inflation in the late 1970s and early 80s was successful, but sent rates sky-high and contributed to a deep recession.

This has major implications, according to Deutsche Bank AG. “We are witnessing the most important shift in global macro policy since the Reagan/Volcker axis 40 years ago,” the lender’s economists said in a June 7 report. “Fiscal injections are now ‘off the charts’ at the same time as the Fed’s modus operandi has shifted to tolerate higher inflation. Never before have we seen such coordinated expansionary fiscal and monetary policy.” The bank said current U.S. fiscal stimulus is comparable with that of World War II, noting annual inflation in America was 8.4%, 14.6% and 7.7% in 1946, 1947 and 1948, respectively.

Across the pond, a top U.K. official frets that there’s insufficient appreciation for the risks inflation poses. Bank of England Chief Economist Andy Haldane, soon to leave his post, has been among the most optimistic about the strength of the U.K. economy. He was the only official to vote to trim stimulus last month. This recovery is far more powerful than that which followed the financial crisis, and persistent price pressures may be hard to escape, he reckons. The BOE is at its most perilous juncture since inflation targeting began in 1992. “The inflation tiger is never dead,” Haldane wrote in an essay in the New Statesman this week. “While nothing is assured, acting early as inflation risks grow is the best way of heading off future threat. This is monetary policy 101.”

Central bankers know how to jack up benchmark interest rates. They have been at it for decades. What they have less experience with is calibrating the exit from quantitative easing: That happened only once in modern history and it was a messy affair. (Japan never really ceased.) Where they have no experience is in recoveries — if that’s truly what we’re seeing — from crippling pandemics. The Federal Reserve, for example, was little more than a toddler when a catastrophic influenza outbreak ravaged the world a century ago.

Doves are right that it is too soon to contemplate rate increases. It isn’t premature to begin sketching a path from the bond buying undertaken since the pandemic began. This is the first step, albeit a potentially fraught one, that we can see on the horizon. Canada has commenced, Australia is contemplating some adjustments, and New Zealand is talking about a modest hike in rates toward the end of 2022–with plenty of caveats.

Officials favoring looser policy are also justified in their skepticism that we’re watching an out-of-control spiral that needs to be cut off at all costs. To proceed down that path, as if on autopilot, is to completely ignore lessons of this still-young century. Experience has to count for something.

It might come down to a question of how far you want to reach into history. Having attended a majority of Fed media lockups during my decade in Washington, and listened to countless testimonies and speeches from monetary chiefs in Asia, Europe and the U.S., my sympathy is with the patient camp. But that rationale has limits. When a thoughtful guy like Haldane speaks in such grave terms, you have to take notice.

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