By: BILL BLEVINS
Financial Correspondent, Blevins Franks
WITH CENTRAL banks in Europe and the UK battling with the fear of rising inflation many people have been casting an eye back to the 1970s when inflation infamously climbed into double digits, followed by interest rates.
Inflation reached a peak in the middle of the 70s. In the UK, the Retail Price Index hit 24.2 per cent in 1975 and did not fall below two per cent until 1993. Interest rates set to restrain the monetary disease remained high through the 1980s before slowly decreasing from 1992.
Could inflation climb to such dizzy heights again?
Inflation through the ages
Inflation is a relatively recent affliction. In the UK, the Office of National Statistics’ composite price index goes back to 1750 and reveals that the cost of living had remained at a relatively low and consistent level until World War II.
Prices increased overall by approximately 140 times between 1750 and 2003 but almost all of this growth happened over the last 70 years. Between 1750 and 1938, prices increased by a little over three times. Since WWII they have increased more than fortyfold.
Supply shocks (a sudden event that increases or decreases output, thus affecting the price of goods) play a significant role. Therefore, inflation used to be mainly affected by harvests and wars. Prices doubled between 1914 and 1920 and increased rapidly again during the first part of WWII. Supply shocks are not always negative, however. The technological changes in the industrial revolution reduced costs through the late 18th and the whole 19th century.
1970s
In the 1970s, inflation spiralled out of control. US President Ronald Reagan warned that it was “as violent as a mugger, as frightening as an armed robber and as deadly as a hit man”.
So what caused inflation to reign unchecked? First, you have to go back to the economic conditions of the 1960s when the flickers of the flame of inflation were ignited. While the swinging 60s raged, new economic powers were emerging and loose monetary conditions, along with strong economic growth, encouraged escalating prices.
Then, in 1973 and 1981, prices tripled due to supply shocks, with a fourfold hike in oil in 1973, provoked by the Arab oil embargo.
The price of oil has always been a major influence. Following the 1973 oil price crisis, the outbreak of the Iranian Revolution in 1979 and fed by fundamental imbalances in the market, oil prices rose steeply.
Trade Unions were another force on inflationary issues in the 1970s when their power over governments seemed unbreakable. Employment has traditionally had an effect on inflation where low unemployment poses a danger of wage increases.
Today
Compared with the rates we saw in the 70s, today’s official inflation figures seem benign. However, the Bank of England, European Central Bank and various economists have made it clear that they have serious concerns about the rise in the cost of living.
One worry is that the economic climate of recent years has been similar to that in the 1960s. The growth of China, for example, with its rapid productivity and incredible capital growth, has been likened to Japan and Germany’s similar fast industrial growth and increasing productivity.
Throughout Europe, higher costs are causing companies to put up their prices, wages (which represent around 70 per cent of a company’s costs) are rising in key parts of the world and some oil exporting countries are spending their profits on infrastructure, fuelling competition for global capital.
Energy prices continue to be the bane of rising inflation pressured by increasing demand and supply concern. The invasion of Iraq a few years ago caused the price of oil to soar and ongoing hostilities mean it remains high. This affects the consumer directly (high petrol costs and utility bills) and indirectly (manufactures increase prices to cover costs).
Inflation, as always, can be affected by outside influences, often unpredictable, such as wars, climate, extreme weather patterns and political unrest.
While inflation has dropped back over the last month, many analysts expect this to be short lived. And there is evidence that battling inflation is even harder today than in the 1980s since the short-run links between economic growth and inflation are declining.
Nonetheless, inflation is unlikely to rise back to its 70s heights. One reason why it rocketed then was a series of errors by policy makers, which are unlikely to be repeated.
While the price of oil remains an issue, we also have positive supply shocks: cheap goods from China, new technology, internet shopping which helps keep prices low and so on. Consumers today have different shopping lists to those of the 1970s, but even the price of mobile phones, iPods, computers and so on have fallen dramatically over recent years.
Some analysts expect that in the long term inflation will rise faster than in the short-term, signalling inflationary pressures to come. Once high inflation gets into the economy it is difficult to fell. Just under a year ago, the Bank of England’s chief economist, Charles Bean, said: “If inflation has settled above target, a deeper or more prolonged slowdown is potentially required to bring it down. That puts an even greater premium on keeping inflation expectations well-anchored around the target”.
No one really knows what causes inflation or exactly how to restrain it. Central banks use interest rates and are keeping a watchful eye on it. One thing is certain – lessons have been made in the past and nobody wants history to repeat itself.
Do you have a view on this story? Email: [email protected]
