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Stephen Roach is getting that 1970s feeling from the Federal Reserve's sanguine view of recent price data

Stephen Roach is getting that 1970s feeling from the Federal Reserve's sanguine view of recent price data
Arthur F Burns, Chairman on the US Federal Reserve, February 1970 – March 1978

Memories can be tricky. I have long been haunted by the inflation of the 1970s. Fifty years ago, when I had just started my career as a professional economist at the Federal Reserve, I was witness to the birth of the Great Inflation as a Fed insider. That left me with the recurring nightmares of a financial post-traumatic stress disorder. The bad dreams are back.

They center on the Fed’s legendary chairman at the time, Arthur F. Burns, who brought a unique perspective to the US central bank as an expert on the business cycle. In 1946, he co-authored the definitive treatise on the seemingly rhythmic ups and downs of the US economy back to the mid-nineteenth century. Working for him was intimidating, especially for someone in my position. I had been tasked with formal weekly briefings on the very subjects Burns knew best. He used that knowledge to poke holes in staff presentations. I found quickly that you couldn’t tell him anything.

Yet Burns, who ruled the Fed with an iron fist, lacked an analytical framework to assess the interplay between the real economy and inflation, and how that relationship was connected to monetary policy. As a data junkie, he was prone to segment the problems he faced as a policymaker, especially the emergence of what would soon become the Great Inflation. Like business cycles, he believed price trends were heavily influenced by idiosyncratic, or exogenous, factors – “noise” that had nothing to do with monetary policy.

This was a blunder of epic proportions. When US oil prices quadrupled following the OPEC oil embargo in the aftermath of the 1973 Yom Kippur War, Burns argued that, since this had nothing to do with monetary policy, the Fed should exclude oil and energy-related products (such as home heating oil and electricity) from the consumer price index. The staff protested, arguing that it made no sense to ignore such important items, especially because they had a weight of over 11% in the CPI. Burns was adamant: If we on the staff wouldn’t perform the calculation, he would have it done by “someone in New York” – an allusion to his prior affiliations at Columbia University and the National Bureau of Economic Research.

Then came surging food prices, which Burns surmised in 1973 were traceable to unusual weather – specifically, an El Niño event that had decimated Peruvian anchovies in 1972. He insisted that this was the source of rising fertiliser and feedstock prices, in turn driving up beef, poultry, and pork prices. Like good soldiers, we gulped and followed his order to take food – which had a weight of 25% – out of the CPI.

We didn’t know it at the time, but we had just created the first version of what is now fondly known as the core inflation rate – that purified portion of the CPI that purportedly is free of the volatile “special factors” of food and energy, where gyrations were traceable to distant wars and weather. Burns was pleased. Monetary policy needed to focus on more stable underlying inflation trends, he argued, and we had provided him with the perfect tool to sharpen his focus.

It was a fair point – to a point; unfortunately, Burns didn’t stop there. Over the next few years, he periodically uncovered similar idiosyncratic developments affecting the prices of mobile homes, used cars, children’s toys, even women’s jewelry (gold mania, he dubbed it); he also raised questions about homeownership costs, which accounted for another 16% of the CPI. Take them all out, he insisted!

By the time Burns was done, only about 35% of the CPI was left – and it was rising at a double-digit rate! Only at that point, in 1975, did Burns concede – far too late – that the United States had an inflation problem. The painful lesson: ignore so-called transitory factors at great peril.

Fast-forward to today. Evoking an eerie sense of déjà vu, the Fed is insisting that recent increases in the prices of food, construction materials, used cars, personal health products, gasoline, car rentals, and appliances reflect transitory factors that will quickly fade with post-pandemic normalisation. Scattered labour shortages and surging home prices are supposedly also transitory. Sound familiar?

There are many more lessons from the 1970s that shed light on today’s cavalier dismissal of inflation risk. When the Fed finally tried to tackle the Great Inflation, it fixated on unit labour costs – rising wages accompanied by sagging productivity. While there are always good reasons to worry about productivity, wages appear to be largely in check; unionised labour, which, in the 1970s had sparked a vicious wage-price spiral through cost-of-living indexation, has been neutralised by global competition. But that doesn’t rule out a very different form of global cost-push inflation – namely, the confluence of supply-chain congestion (think semiconductors) and protectionist clamoring to reshore production.

But the biggest parallel may be another policy blunder. The Fed poured fuel on the Great Inflation by allowing real interest rates to plunge into negative territory in the 1970s. Today, the federal funds rate is currently more than 2.5 percentage points below the inflation rate. Now, add open-ended quantitative easing – some $120 billion per month injected into frothy financial markets – and the largest fiscal stimulus in post-World War II history. All of this is occurring precisely when a post-pandemic boom is absorbing slack capacity at an unprecedented rate. This policy gambit is in a league of its own.

For my money, today’s Fed waxes far too confidently about well-anchored inflation expectations. It also preaches the new gospel of “average inflation targeting,” convinced that it can condone above-target inflation for an unspecified period to compensate for years of coming in below target. My students would love to throw out their worst grade(s) as well!

No, this isn’t the 1970s, but there are haunting similarities that bear watching. Timothy Leary, one of the more memorable gurus of the Age of Aquarius, purportedly said, “If you remember the 1960s, you weren’t there.” That doesn’t apply to the 1970s. Sleepless nights and vivid flashbacks, complete with visions of a pipe-smoking Burns – it’s almost like being there again, but without the great music.

Stephen S. Roach is a faculty member at Yale University and the author of Unbalanced: The Codependency of America and China. Copyright: Project Syndicate, 2021, published here with permission.

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Great reading... Thank you

Yes, one of the best!


Lessons; The CPI doesn't necessarily cover the things people need to buy in their daily lives, so pinning "cost of Living" increases to the CPI is a fundamentally flawed concept. What is needed is a separate measure that continually assesses the actual "Cost of Living". Politically fraught I would think?

It is a deliberate policy to try and inflate the debt away, essentially eroding your standard of living.

The hidden tax

Great article

Simple equation bankers do not like to talk about, nor finance ministers. It is:

Wage rises below cost of living rises = misery.
Also: income to service debt falling as debt rises = trouble. ie defaults

The RBNZ publishes a 'key graph' on the relationship between household disposable income and debt servicing cost. That cost has never been lower, which may be why bankruptcies and NAPs have also never been lower.

Given that all banks assess mortgage borrowers at an interest rate far above the rate they approve the loan at (currently about 6.25%), it seems unlikely a flood of defaults are coming any time soon.

Servicing is a percentage of disposable income currently around 6%. Data comprises of mortgages, credit cards and student loans.

Interesting, considering student loan payments for ex. are usually 13% of ones gross pay, so it's clear these numbers are aggregate include the h'holds with no debt at all. As home ownership rates are falling, one can assume the % of h'holds with mortgages are also falling. So effectively the debt servicing costs are being diluted by more and more people who cannot obtain the debt to begin with (renters). Doesn't paint an accurate picture to those with debt.

If only there was data based on those with mortgages and broken down into age demographics, but this information is probably the best we have.

Agreed. but a decline in economic activity may come somewhat earlier than defaults
Keith W

Exactly Keith this is so often over looked.

Hi David

that is mortgage debt.
As you know, corporate debt in USA and China is atrocious and China is attempting to revolve 70% of its debt in 2021 and defaults are increasing there, as interest reported this week. Also, government defaults happen: Argentina. Turkey looking v dodgy too. Basically, a hell of a lot of bonds are going to lose money and rates cannot go up.
Rates do not have to go up to cause defaults. All that is needed is living costs to exceed wage rises to shrink the amount available to service debt.
Debt was not thought to be a problem in 2006-07 either. Til it was.
Counter parties do not know who holds what and under what leverage, until the manure hits fan. Then you get a liquidity freeze.
As you know, world debt is 40% higher than it was in 2008. rates are not sole thing that makes a difference to default risk.

Good points Mike
Mortgage debt in short-run is relatively fixed yet living costs are increasing more than ever. Many local govt bodies rates increases already signaled are yet to be billed as well.

Great read - shows the world has been living above its means for decades. Very little thinking happening right now around the current macro-environment. But the human condition is to avoid discomfort at all costs, and it seems max possible consumption will continue until austerity is unavoidable (simple), or someone gets the mandate to greatly increase energy production and reuse our resources wisely (complex).

Would love to see a follow up article to this about how CBs targeting inflation rates broke Bretton Woods, the giant pendulum swing away from this, and the unenviable choices ahead for CBs if inflation targeting slips from their grasp in the face of a mountain debt that can never be repaid. Especially drawing comparisons to the Weimar Republic. History is our greatest playbook, and we think we're immune from it at our own peril.

CBs targeting inflation - pioneered in NZ and adopted around the world - became a necessity once the Bretton Woods link to gold was broken by Nixon. But as Roach recounts, CBs are again creating a problem by using inflation measures that underestimate the true CPI such as hedonic pricing. It took Volcker's punishing near 20% fed funds rate to slay inflation then. But today we've got Powell (and Orr) instead of Volcker with global debt:GDP much higher than it was in the 1970s, so I'm getting that dreadful 1930s feeling.

Yes and there are a number of other macro market commentators saying the say thing...Dalio keeps hitting on look at the 1930 - 1945 period to understand what is evolving.

correct - we are living way beyond means & choosing NOW over LATER- that is reflected in growing debt pile & requirement to increase the leverage into the future.
But this is also what pays "wages" .... thats the kicker

"someone gets the mandate to greatly increase energy production and reuse our resources wisely.."

They did!

It was called
- Shale Oil (who cares if it is destined to go bust ... just add to NOW's output
- More coal plants
- more dams
- more nutrient load
- higher stocking rates
- more rainforest down / wetlands drained etc etc

We cant unhook resource burn & the value of money/debt for long ... somethings gotta give

Is this powerdownkiwi's smurf account??

Great Read.

What is meant by; "by allowing real interest rates to plunge into negative territory in the 1970s"? Does this just mean interest rates were lower than inflation?


Slightly unnerving recount that to me, evoked images and consequences of our Robert Muldoon’s prime ministership. It is astonishing how power develops into infallibility just as much as arrogance is consistently coupled with ignorance.

Real interest rates in NZ are negative
What is real inflation rate?

Whatever the real inflation rate is, it's only transient don't you know...

History never repeats
I tell myself before I go to sleep

Here is a quote to ruin your sleep: "Those who do not remember the past are condemned to repeat it."
George Santayana

When you're running exponential resource extraction on a finite planet

History does, indeed, never repeat.

This is the first we have come up against the planetary limits, and is indeed the only time we can run the experiment. Pit the media are MIA at this critical juncture. It's not as if they haven't had it put under their noses......

The US had almost run out of oil until they discovered fracking. Humans are incredibly resourceful, we just need austerity to flick the switch.

Or is this ham n eggs's smurf account???? Smurfception!