The Great Inflation – could it happen now?

The Great Inflation started with the economic policies of the Kennedy and Johnson administrations in the 1960s, and it ended during the first term of President Reagan’s administration in 1982. Low levels of inflation, in general, promote price stability and a healthy economy. However, high levels of persistent inflation, such as those experienced during the Great Inflation, cause uncertainty and doubt – inflation takes away people’s faith in the future, because they don’t know what prices to expect or what price shock will happen next.

Robert J. Samuelson, in a book titled The Great Inflation and its Aftermath, provides a key concept: The reason for “The Great Inflation” of the 1970s was an idea.[1] That idea was the concept of “full employment.” The concept of full employment was simple – by using the unemployment rate as your guide, you can manage the economy to attain the maximum possible level of employment in the country. Politicians like to say they are bringing jobs to their respective districts, because that is what keeps voters happy and gets the politicians re-elected. However, by focusing too much on the ideal – in addition to a misunderstanding of the real level of unemployment that is equivalent to full employment – the government actually made inflation worse.

The policy makers in the White House, in conjunction with the economic advisors and staff at the Federal Reserve, were targeting a full employment level that translated to a 3.5% to 4% unemployment rate. That is much lower than the now academically accepted meaning of “full employment,” which is 6% unemployment (there is always a minimum level of joblessness – frictional unemployment – that is due to staff turnover, seasonal staffing, summer job for students, etc., that cannot be eliminated).[2] Any unemployment level of less than 6% causes wage inflation, due to competition for scarce labor resources. This means that economic policy and policy decisions, if not directly the causes of the persistent and intransigent inflation of the 1970s, certainly made it worse.

It is also interesting to note that the Federal Reserve’s stated goals for Federal Open Market Committee (FOMC) activity are an inflation rate of about 2% and unemployment rates of 5.2% to 6% (the “dual mandate” of low inflation and low unemployment discussed in former Fed Chairman Ben Bernanke’s speech at a conference for the National Bureau of Economic Research, Cambridge, Massachusetts on 10 July, 2013).[3] This means the Fed’s monetary policy objectives are similar to those carried out by his predecessors in the 1970s.

The following chart of US annual inflation figures from 1948 to 2011 shows the rise and fall of inflation over the last 60 years, which approximately mirror the last Kondratieff cycle. This figure also shows a 4th order curve fit of the data, depicting the natural cycle of inflation data, which reveals a Krondratieff wave. This figure provides us a clue as to where inflation rates should be headed – higher.

Annual U.S. Inflation (1948-2011)[4]

[1] The Great Inflation and Its Aftermath (The Past and Future of American Affluence), by Robert J. Samuelson, 2008, Random House Publishing Group, New York, New York, page 71

[2] Ibid, page 58

[3] Speech by Ben S. Bernanke, Chairman Board of Governors of the Federal Reserve System, at a conference for the National Bureau of Economic Research, Cambridge, Massachusetts on 10 July, 2013

[4] Source data from U.S. Bureau of Labor and Statistics website, www.bls.gov, graph by the author

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