Across over Rich world consumer prices are rising by 10% a year, the highest rate since 1983. That year holds a special place in the history books. It was the last year, after many, in which annual inflation was in double digits. Then it went down, paving the way for the low inflation of the 1990s.
Today’s central bankers hope to repeat this trick and thus enter the monetary policy hall of fame alongside the veterans of the 1980s. Paul Volcker, who headed the Federal Reserve from 1979-87, is the greatest of all. But Canada’s Gerald Bowie, Carlo Azeglio Ciampi in Italy, and Karl Otto Pohl in Germany—who likened inflation to toothpaste (“once it’s out, you hardly get it back”)—also presided over disinflation in that decade.
Central bankers hope their job won’t be too difficult. The Fed’s projections suggest inflation will remain close to the target through 2024 at the cost of a slight increase in unemployment. The current period of high inflation is relatively short, so hopefully expectations of price pressures are not compounded. Others say the price increase is largely driven by supply-side constraints, which should fade quickly. However, over time, the rise in inflation appears to be widespread almost everywhere. Expectations seem stubbornly high in many places.
So the experience of the 1980s can be instructive. And once you dig into history, the decade holds three hard lessons for today’s policymakers. First, inflation may take a long time to come down. Second, taming inflation requires the participation of not only central bankers but also other policy makers. And third, it will come with big trade-offs. The question is whether today’s policymakers can navigate these challenges.
First take the path of deflation. In the 1980s it was a slog. Italy saw more rapid success than most. Under Ciampi the central bank moved from playing the treasury to a semi-independent entity: inflation fell from 22% in 1980 to 4% by 1986. But that still meant five long years where prices rose more than 10%. Even if today’s rich world de-inflates as quickly as Italy, its average inflation rate will not fall to 2% before the end of 2025.
In any case, many countries had more problems than Italy. Rich-world inflation declined in 1980–81, but progress stalled in 1982–83. Then in 1987-88 there was another inflationary spike, fueled by energy costs. Inflation has increased in some countries. In early 1984, with inflation at 3.5%, New Zealanders wondered if they had killed the monster. However, by mid-1985, it had exceeded 16%. We estimate that in 53% of the months of 1980 inflation in the average rich country was lower than the previous month. Disinflation was happening, but often it didn’t feel like it.
A second lesson of the 1980s is that central bankers can only do so much. “Monetary policy alone did not beat inflation in the 1980s,” John Cochrane of Stanford University argues in a new paper. Some say the liberalization reforms of the 1980s helped the fight, increasing competition and lowering prices. imf Research has found that labor- and product-market reforms can, under certain conditions, lower prices. These reforms, however, likely took some time to kick in.
Economists can make a strong case for the role of fiscal policy in the fight against inflation. In the 1980s, policymakers around the world recognized that lax fiscal policy could add fuel to the inflationary fire, as they had not done in the 1970s. Even as households’ real incomes fell, they lagged behind to spend. Mr. Cochrane pointed out that America’s primary budget deficit (that is, excluding interest payments) was significant “especially given the severe recessions of 1980 and 1981-82.”
Governments elsewhere were hard-nosed. Japan narrowed its primary deficit from 3.2% gdp In 1980 until 1985 it reached a surplus. Denmark experienced a difficult period of austerity. France also kept a tight lid on borrowing. Today, a growing number of economists are urging policymakers to learn these lessons. In a new piece by Tobias Adrian and Vitor Gaspar imf argue that “[f]iscal accountability … shows that policymakers are geared against inflation. They estimate that a given fiscal tightening can reduce core inflation by as much as a dose of monetary austerity.
A third lesson of the 1980s is that disintegration is painful. The world economy did not benefit from a “soft landing,” where inflation falls without triggering a recession. Average unemployment in the rich world has doubled in the five years since 1979. Some parts of the economy have collapsed. House building, for example, fell by a fifth in 1980-82.
Unsurprisingly, therefore, there was anger. A carpenter sent Volker a plank of wood in the post—a symbol of no need for wood because someone bought a house. Car-workers shut down highways in Canada. Yet policymakers stayed the course, showing the public that they were dead serious about bringing inflation under control.
This was acceptable in the 80s
Do today’s policymakers have the guts to fight? Coming so soon after the fiscal austerity of 2010, many are reluctant to tighten the tax-and-spend screw once again. Indeed many politicians have gone the other way, and now seem uncomfortable with the notion that anyone should lose out on anything. They are providing hundreds of billions of dollars-worth of deficit-financing aid that will fuel inflation, whether by subsidizing energy bills (in Europe), “cost-of-living payments” (in Australia and New Zealand) or exempting students. Debt (in the US).
Policymakers are thus ignoring the fundamental lessons of the 1980s. Fighting inflation is hard. It requires all hands on deck, and great courage in the long run. It is also, unfortunately, almost inevitable that some groups will lose, if only in the short term. As politicians fear, the 2020s also risk earning a special place in the history books – for failing to control inflation. ■
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Only a revitalized economy can save China’s property industry (Nov 17)
Interest rates have increased sharply. But is monetary policy really tight? (November 10)
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