Will the 2020s Repeat the Great Inflation of the 1970s?

The following is an excerpt from our Morning Briefing.

At Yardeni Research, we have been spending lots of time putting together lots of chart books on inflation so we can carefully monitor the current situation. Our latest is titled The Great Inflation of the 1970s. We are using it to track the similarities and differences between the 2020s and the 1970s. We’ve done so before but want to focus now on one of the most important differences: Productivity growth collapsed during the 1970s, while it is showing signs of rebounding in recent years and could fuel a productivity-led boom if our Roaring 2020s scenario pans out. Consider the following:

(1) Streak of inflationary bad luck. As we’ve previously noted, everything that could go wrong on the inflation front did so in the 1970s. President Nixon closed the gold window on August 15, 1971. During the decade, the foreign-exchange value of the dollar plunged by 53% relative to the Deutsche mark, and the price of gold soared 1,402% (Fig. 1 and Fig. 2).

The CRB raw industrials spot price index, which was relatively flat during the 1950s and 1960s, jumped 165% during the decade as a result of the weaker dollar. A supply shock in late 1972 through early 1973 sent soybean prices soaring (Fig. 3). As a result of the oil crises of 1973 and 1979, the price of a barrel of West Texas Intermediate crude oil rose 870% from $3.35 at the start of the decade to $32.50 by the end of the decade (Fig. 4). Cost-of-living adjustment clauses in labor union contracts caused these price shocks to be passed through into wages, resulting in an inflationary wage-price spiral (Fig. 5). (For more on the Great Inflation, see the excerpt of my 2018 book.)

(2) When the cost of labor soared. We can see what happened more clearly by focusing on the 20-quarter percent change, at an annual rate, in hourly compensation, which includes wages, salaries, and benefits (Fig. 6). This measure rose from a low of 3.5% through Q2-1965 to a high of 11.4% through Q1-1982. Meanwhile, productivity growth, measured on a comparable basis, dropped from a peak of 4.6% through Q1-1966 to zero through Q3-1982. Unit labor cost (ULC), which is the ratio of hourly compensation to productivity, soared from about zero per year during the first five years of the 1960s to over 10.0% during the late 1970s and early 1980s (Fig. 7).

(3) Rise and fall of inflation. The core PCED inflation rate is closely tied to the trend growth rate in ULC. Both rose dramatically during the 1970s as a result of the wage-price spiral, which was exacerbated by the collapse of productivity. During the 1980s, both fell sharply as hourly compensation growth slowed dramatically while productivity growth improved. Since the mid-1990s, both the ULC and core PCED inflation rates hovered in a range between zero and 2.0%.

(4) Where are we now? During Q1-2021, the 20-quarter growth rates, at an annual rate, in hourly compensation, productivity, and ULC were 4.3%, 1.9%, and 2.2%, respectively. The core PCED was up 1.8% y/y during March. Severe labor shortages suggest that hourly compensation growth is likely heading higher in coming quarters. We expect that productivity growth will keep pace with hourly compensation, resulting in ULC growth remaining around 2.0%.

If so, then the PCED inflation rate should settle around there as well following the current base-effect pickup in the price inflation rate. More specifically, we expect that inflation will run around 3.0%-4.0% through the summer and fall back to around 2.5% later this year.

(5) What could go wrong with this benign outlook? The decade of the 1970s offers the most plausible cautionary tale. Over the past year, both food and nonfood commodity prices have risen sharply, and the dollar has fallen. Soon, there should be more signs that wage inflation is picking up. In recent weeks, Amazon and Walmart have announced plans to boost compensation for their workers. On May 18, Bank of America said that it will raise the hourly minimum wage of its US employees from $20 to $25 by 2025. The bank will also require its vendors and suppliers to pay their employees at least $15 an hour, with 99% of vendors already doing so, according to CEO Brian Moynihan.

Nevertheless, we don’t expect a wage-price spiral. We do expect that rising wages will be justified by rising productivity.

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