Mark Twain once said that “history doesn’t repeat itself, but it does rhyme.” That’s worth thinking about when comparing the current economy to the woes of the 1970s.
As they did three decades ago, surging oil prices are exacerbating inflationary pressures, further damaging a weak economy. The question is whether the toxic combination that produced stagflation then, crippling growth for years, is beginning to play out again today.
Federal Reserve Chairman Ben Bernanke is vowing to prevent that from happening, insisting the Fed is on the case. “Maintaining confidence in the Fed’s commitment to price stability remains a top priority as the central bank navigates the current complex situation,” he said in a speech earlier this month.
But few Fed watchers are counting on him to back up that talk with action anytime soon.
The Fed left the overnight borrowing rate at the ultra-low rate of 2 percent Wednesday following its regular two-day meeting. And many are betting Bernanke won’t act until after the November election, fearful that an even small dose of tighter monetary policy will slam the economy and affect the outcome of presidential and congressional balloting.
Still, even if he waits that long, a case can be made that Bernanke has a bit of breathing room before runaway inflation could take hold.
For one thing, energy consumption by households and businesses represents a much smaller percentage of their total income than in the 1970s, so the higher prices aren’t effecting them as badly just yet. At the same time, productivity is much stronger now and unit labor costs have barely grown in the last year.
He also has history as a guide about what not to do.
Back then, the OPEC oil embargo sent crude prices soaring from $3.77 a barrel in May 1973 to above $12 by January 1974. Another price surge came later in the decade following the Iranian revolution, which pushed crude prices from around $14 a barrel in 1978 to above $30 two years later, according to Lehman Brothers.
As inflation rose over that decade to almost a 12 percent annualized rate — more than three times the annualized rate of 3.6 percent over the last four years, according to Citigroup — economic growth stunted and the dollar remained weak. Wage pressures also soared as workers demanded higher incomes to offset their higher costs.
But the Fed back then was lax in dealing with inflation, continuing to keep interest rates low to stimulate the economy even as prices accelerated.
It wasn’t until Paul Volcker took the helm of the Fed in 1979 that the attack on inflation began. The supply of money and credit were tightened, and the central bank pushed short-term interest rates as high as 20 percent. The efforts worked, but the U.S. economy fell into a deep recession.
Today, Bernanke is up against oil prices tripling over the last four years, and showing eight-fold gain in the last decade to now trade around $137 a barrel, according to Citigroup. Those price gains, coupled with a big upswing in other commodity costs and a steep decline in the dollar, is beginning to creep into other parts of the economy, which has been close to stalling in recent quarters.
Last week, the government reported that wholesale prices of finished goods rose 1.4 percent in May, raising the 12-month increase to 7.2 percent. That matched the findings of a new survey of chief financial officers at public and private companies, which found that 45 percent of the 468 respondents said their firms were passing along higher fuel costs to customers by raising prices, according to the June Duke University/CFO Magazine survey.
Stagflation worries were on the minds of 87 percent of the more than 200 mutual fund managers surveyed by Merrill Lynch earlier this month, and that’s causing an alarming number to shift away from owning stocks and into cash.
Bernanke knows that the public’s perception about inflation means a lot. That’s why he and other Fed official have been talking about why this time will be different.
In a speech earlier in June, Bernanke noted that if people expect higher prices to be temporary and don’t build them into their longer-term plans for wages and prices, then the inflationary pressures caused by higher oil prices will fade “relatively quickly.”
Still, indications of longer-term inflation expectations are a “significant concern” for the Fed, he said. That suggests the Fed eventually will have to raise borrowing costs even if the economy is still struggling to pick up speed.
Whether that means a few small steps will work, or if Volcker’s strong medicine is needed, is still an open question. But the message Bernanke wants to leave with us is that he is up to the task. Time will tell.