By: Phil Kernen
Inflation is ramping up and settling in. To assess where prices might head, we can learn a few things by looking to the past.
The inflation of the 1970s, while not exactly like our current situation, is only the most recent example of runaway prices. The Great Inflation, which began in the 1960s, evolved from the policies of the Johnson administration. Domestic priorities and the costs of war led to additional spending in an already growing economy. The lack of offsetting taxes compounded the problem. Money entered an economy that had little additional supply capacity for more demand, leading to price increases. Sound familiar so far?
According to a paper from the National Bureau of Economic Research, policymakers in the 60s were also trying something new. They decided to drive unemployment lower and allow higher inflation in exchange. It worked too well. They didn’t get just inflation, but accelerating inflation. The Federal Reserve finally started raising rates in 1979 to get ahead of the problem. By 1982, through two short recessions, inflation was finally declining. Higher unemployment and higher interest rates were the tradeoffs.
The problem with inflation was and is expectations. Monetary policy leaders often talk about well-anchored inflation expectations, a common refrain from current Federal Reserve leaders over the last decade. It means that businesses and consumers can plan for the future without factoring in high inflation, easier done when they expect inflation to stay low. When those expectations change, policymakers get concerned.
Inflation expectations changed in the 60s and 70s. When it became clear the Federal Reserve prioritized employment over inflation, which was starting to move higher, consumers and businesses took matters into their own hands. Workers expected higher prices, so they demanded higher wages. Business leaders expected to pay higher wages, so they raised their prices into an ever-growing wage-price spiral.
At the time, union membership in the U.S. was still strong. General Motors agreed to the first Cost of Living Adjustment (COLA) in 1948, but it took the Great Inflation for more unions to start pushing harder for COLA protections in their contracts. And they demanded longer contracts too. By 1976, more than 60% of union contracts contained COLA protections, locking in income certainty for two or three years instead of the usual one.
Once inflation broke in the early 1980s, foreign competition led to cost-cutting programs from managements who tried to eliminate COLAs where possible. Even so, 56% of contracts still included COLA protection in 1985. By 1995, after more than a decade of low and manageable inflation, that percentage had dropped to 22%. By then, wage gains from COLAs were near record lows, leading many more contracts to discontinue their inclusion altogether. Worker and business inflation expectations had moderated materially.
That might be changing now. The Wall Street Journal reported that Deere & Co., after removing COLAs in 2015, recently agreed to reinstate them into employee contracts over concerns that wage increases wouldn’t cover higher living expenses. The contract calls for a restart bonus, an immediate 10% raise, more raises in future years, and wages will be adjusted each quarter based on inflation. The agreement came together amid the fastest rise in consumer prices in 30 years in October – year-over-year CPI increased 6.2%.
If anchored inflation expectations are the rock upon which the Federal Reserve continues its loose monetary policy, consider this another crack in the foundation. Union representation is significantly smaller than in the 1970s, so we don’t expect a flood of new COLA-heavy union contracts to change the inflation narrative. But added to the growing number of companies increasing wages to remain fully staffed and meet strong consumer demand creates concern. All wage-price spirals have to start somewhere.