Roaring Twenties or Stagnant Seventies? The return of stagflation 

As the world emerges from the Covid-19 pandemic a new crisis is brewing on the horizon: stagflation”. A portmanteau of inflation and stagnation, the term was coined in 1965 by Iain Macleod, the Tory politician and editor of the Spectator. The post-war boom – the so-called Golden Age of Capitalism” – was followed by recession, unemployment and soaring inflation.

This was a significant challenge to the prevailing orthodoxy of the time – Keynesianism – as illustrated by the Phillips curve, which posits that when inflation is high, unemployment is low – and vice versa.

Yet the Golden Age of economic growth, full employment, booming consumer credit and collective bargaining was followed by price controls, tariffs, industrial action, devaluation and the collapse of the Breton Woods system in the 1970s. The onset of the OPEC oil embargo in 1973 was merely the final nail in the coffin for policymakers struggling to square the circle of stagflation”. 

Of course, the world in the 2020s is radically different to that of the 1960s and 1970s – more globalised, less unionised and more energy diverse. We are also currently living through a unique period of history for which there is no real prior comparison. And yet, as we emerge from the pandemic there are certainly parallels with the stagflationary era.

For starters, inflation. Wages, commodity prices, retail prices and property prices are all soaring. Last week, it emerged that factory gate prices in China, the workshop of the world, have risen to a three-year high. Goldman Sachs expects oil to hit $80 a barrel this summer, the largest ever demand jump. The US has recorded its highest rate of inflation since 2008, at the height of the financial crisis, and the latest inflation figures in the UK, announced tomorrow, are expected to double from 0.7 per cent to 1.4 per cent.

Of course, this is largely thanks to Covid-19, which has both created constraints on supply (cost push inflation) and led to rampant bursts of pent-up demand (demand pull inflation) as populations emerge from lockdown. 

But, as in the post-war period, it is also thanks to inordinate levels of government spending: the UK has spent $372 billion in response to the pandemic. The US, which had already spent hundreds of billions of dollars under Donald Trump, is set to spend $6 trillion under Joe Biden. Much of this has come in the form of support schemes – loans, benefits, furlough – and, according to Moody’s, there is an estimated $5.4 trillion stockpile of consumer savings around the world.

The spending of this money is, of course, vital to the global economic recovery. But it also a basic tenet of economics that increasing the money supply at a rate greater than economic output will lead to inflation. It certainly seems that we are in the grip of Modern Monetary Theory — or, as its detractors call it, the Magic Money Tree Theory — which argues that governments in control of their currency can print money indefinitely and never run out of it. The father of monetarism, Milton Friedman, referred to it as helicopter money” – money falling out of the sky. 

Some even argue that central banks, in collaboration with governments, might be engaging in financial repression” – as post-war American governments did to reduce their debt-to-GDP ratio. In other words, deliberately suppressing interest rates through quantitative easing (QE), the process by which central banks buy government bonds, thus increasing their price, suppressing their yield and making government debt, which has soared the world over, less expensive. 

At present, central bankers certainly seem relatively calm about rising prices. According to the Federal Reserve chair, Jerome Powell, and the Bank of England governor, Andrew Bailey, the current surge in inflation is a Covid-based and transitory” or ‘temporary” phenomenon. Their thinking is that inflation is rising in 2021 because of the base effect of deflationary pressures in 2020. 

But inflation, which makes everybody poorer by making money worth less tomorrow than it is today, is not only being felt by businesses and consumers. Investors are particularly wary, with stock markets across the world sliding on news of inflation figures last week. All eyes are on the central banks to see if they will raise interest rates – the traditional means of curbing inflation by encouraging people to save rather than spend – as the Thatcher and Reagan governments did in the 1980s.

But this too has costs. Not only do rate rises curb economic growth (both Reagan and Thatcher incurred recessions), they also benefit creditors rather than debtors, and two key interest groups comprising the latter: mortgage holders and governments. In the UK, for instance, even a single percentage rate rise in interest rates would add £20 billion to the government’s debt repayments, while even a moderate increase in the cost of mortgages could crash the housing market according to one analyst.

This is why a new era of inflation could lead to stagflation, as it did in the 1960s and 1970s. Temporary inflation might be manageable, but an inflationary spiral affects interest rates, economic growth and, therefore, employment. As the saying goes, controlling inflation is like trying to catch a tiger by its tail. The Bank of England‘s chief economist, Andy Haldane, used this analogy in a recent speech and was the only member of its Monetary Policy Committee to vote to taper QE this year. He is now leaving the Bank. 

Of course, the Bank also forecasts the UK to enjoy its fastest growth in 70 years (strong growth in the US, EU and China is also expected), and such growth would help to keep inflation and unemployment at bay. The latest figures for the UK today show that the unemployment rate fell in the first few months of this year. 

But with millions of workers still being furloughed, the true impact of Covid on the labour market in this country remains to be seen. This is not to mention our low productivity, ageing population and exodus of migrant workers post-Brexit. More alarmingly, in the US, unemployment has actually risen despite, or perhaps because of, Biden’s trillion-dollar stimulus, fuelling Republican criticism of the Democrats’ welfarism.

As for the UK, the Conservatives’ reputation as the party of fiscal responsibility, low taxes and home ownership would be in jeopardy were inflation, interest rates and unemployment to rise significantly. Ed Miliband’s claims of a “cost of living crisis” never really stuck in an era of growth, low inflation and low interest rates. Twenty years before, it took Black Wednesday to undermine the economic credibility of the Conservatives under John Major and pave the way for Tony Blair. Yet if Boris-onomics comes unstuck, it could yet do the same for the hitherto hapless Sir Keir Starmer.

It is too early to say for sure whether we are approaching Stagflation 2.0. Inflation might yet prove temporary; recession and unemployment might be avoided. But the warning signs are there and governments and central banks have a gargantuan task on their hands. 

So, beware comparisons with the Roaring Twenties. We might be heading for the Stagnant Seventies.

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