In the 1970s, inflation was increasing, federal government budget deficits were escalating, energy prices were rising, interest rates were spiking, and the country was gripped by a wage-price spiral. Fed Chairman Arthur Burns and President Jimmy Carter didn’t seem to know what to do. Disastrous results followed.
Today we are experiencing high inflation, huge government budget deficits, high energy prices, elevated interest rates and the beginning of a wage-price spiral. It looks like Fed Chair Jerome Powell and President Joe Biden are trying to be Burns and Carter.
Early in the 1970s energy prices rose substantially and there were shortages of gasoline. The resulting high energy prices put upward pressure on all prices and inflation increased. Price controls were tried, but as they always do, failed to slow inflation.
Eventually, the high inflation led to a recession in 1973 and a double dip recession in 1975. Fed Chair Burns was reluctant to raise interest rates and, except for a brief time in the mid-1970s, kept the Federal Funds Rate near 5%. That relatively low rate added to the excess demand that kept inflation growing.
Instead of taking action that would increase the supply of energy and reduce prices, Carter tried to convince Americans to use less energy. In 1977, Carter gave his famous “moral equivalent of war” speech, pleading with Americans to reduce consumption of energy by driving cars less and lowering the thermostats in homes during the coldest winter months.
That speech did little to reduce demand.
Also, during the 1970s, labor sought much higher wage increases just to keep up with rising prices. The increased labor cost forced corporations to raise their prices even more, in order to maintain profitability. This led to the wage-price spiral.
Beginning in 2021, both the huge federal government budget deficits and the shockingly irresponsible monetary policy led to high inflation. Biden, like Carter, increased the annual budget deficits. And Powell, like Burns, kept interest rates too low for too long.
How did the U.S. fix this in the 1980s?
Paul Volker replaced Arthur Burns as Fed chair in 1979. After Milton Friedman won the Nobel Prize in Economics in 1976, his theories about controlling the rate of growth in the money supply became mainstream. Volker followed Friedman’s policy suggestions.
Volker slowed money supply growth and pushed interest rates to extremely high levels. Noting that inflation reached 13.5% in 1980, Volker said that the extremely high interest rates would take enough demand out of the economy to put downward pressure on prices and eventually reduce inflation.
The problem was that taking that much demand out of the economy would cause a recession. It turned out that the recession that followed was very severe as the unemployment rate topped 10%.
It takes time for the high interest rates to bring inflation down. Inflation did, however, fall to 3.2% by 1983.
Biden, like Carter, has taken no action to increase energy production in the US. In fact, his policies have reduced energy production in both the short term and the long term.
Some will point out that we are producing more oil today than when Biden took office. And that is true, but…
Prior to Biden taking office, the U.S. produced 12.5 million barrels per day. Shortly after Biden implemented his policies, daily production fell to 11 million bpd. Today, mostly because of higher prices, oil companies have increased daily production to 12.7 million bpd.
However, had Biden not canceled the Keystone pipeline, not withdrawn leases to drill on federal land, and not made the permitting process much more difficult and expensive, U.S. oil production this year would exceed 14 million barrels per day. Biden is becoming another Carter.
Worse is the performance of Fed Chair Powell. In 2021 with the economy growing at a 6% annual rate and with the unemployment rate tumbling downward toward 3.5%, Powell kept interest rates near zero. He also vastly increased the money supply by purchasing $240 billion of government securities monthly.
That vastly increased demand in the economy and led to high inflation. And now we see the beginning of the wage price spiral. The problem with wage increases in the 7% range and contracts lasting up to four years is that inflation is becoming embedded in the economy. Still Powell, like Burns, paused interest rate increases.
We must hope that these actions don’t lead to a severe recession like the one we had in 1980/81.
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