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By: Simon Constable
Constable, a former Wall Street Journal TV anchor, is a fellow at the John Hopkins Institute for Applied Economics, Global Health, and the Study of Business Enterprise.
It’s been an age since Americans last suffered inflation. But the beast came back with a vengeance last year. The Federal Reserve thought it was transitory at first, but it wasn’t. Inflation in the US rose to a whopping 8.9 percent in July 2022, up from around zero at the beginning of 2015. The near-9 percent peak was the highest since 1981.
The rate, as we know, has fallen quite a bit since—hovering around 3 percent by early fall. But the government hasn’t accomplished the goal of pushing it to 2 percent, and many don’t think it will succeed. Others worry the rate will creep back up.
It begs the question: Why is inflation so difficult to beat?
The answers are elusive, but history tells us a lot. Inflation peaked three times during the 1970s: in 1970, 1974, and 1980. Each time, the Fed quickly lost credibility due to its repeated failures to tame the beast.
“The Fed engaged in a stop-and-go monetary policy,” says Robert Wright, a senior research fellow at the American Institute for Economic Research. After raising interest rates to halt inflation, it took its foot off the brake too soon and the rate jumped back up again, leading people to expect inflation to continue or even accelerate.
Such expectations are dangerous because they become embedded into the economy. “When people expect inflation to continue, then they expect they will get a higher wage and will dip into their savings more,” Wright says. A “buy now” psyche tends to emerge, as people seek to lock in prices before they increase. As things sell faster, vendors have no incentive to cut prices, leading consumers to keep dipping into savings, which in turn sustains inflation. In this way, inflation becomes the foregone conclusion of a vicious cycle.
"Once the Frankenstein inflation monster is breathing, it is very alive…”
It took the huge credibility and determination of Fed chairman Paul Volcker, combined with the efforts of the Reagan Administration, to push inflation down to 3.2 percent by 1983. However, inflation didn’t get below the 2 percent target until 1986, making the inflationary surge more than a decade and a half long.
One of the current problems in taming inflation is the lack of government credibility, says David Ranson, president and director of research at financial-analytics firm HCWE & Company. He points to the combination of massive relief payments and excessive money printing that we saw during the pandemic. He likens this to a helicopter dropping dollar bills onto the street—an all-but-certain recipe for raising inflation.
Such actions tend to do no good for the economy. “It degraded the credibility of the US monetary system, and there is every expectation the government will do it again,” Ranson says. The worry is that a repeat performance of money printing will push inflation back up. In turn, that will give greater momentum to the vicious cycle of higher inflationary expectations.
Another part of what has happened lately is a misunderstanding of how inflation works, says Pippa Malmgren, an entrepreneur and former economic advisor to President George W. Bush. “There’s an accepted idea that you can have a little bit of inflation,” she says. But the reality is quite different: “Once the Frankenstein inflation monster is breathing, it is very alive, and it’s very hard to kill.”
It’s also true that the inflation of today isn’t the same as that of the 1970s. Malmgren says the current situation has been caused, at least partially, by two factors: disruption in the supply chains for energy and food due to the war in Ukraine; and the unusually prolonged shutdown of the Chinese economy. “We need new little companies to start making food and energy and manufacturing goods,” she says. “You can’t get those companies to come to life if you raise interest rates.”