German flags waving in the wind at famous Reichstag building.
There are parallels between today’s economic landscape and the inflationary upswing of the 1970s, giving reason for caution and showing signs that a soft landing may be overly optimistic. Specific indicators, especially in prominent economies like Germany, hint at a possible re-acceleration of inflation.
The 1970s marked a period of severe inflation, with interest rates in many developed economies reaching double digits. This inflationary upswing was primarily driven by two oil price shocks, which led to a surge in energy prices. The ripple effects of these price increases were felt throughout the economy, pushing up the cost of goods and services and eroding the value of money.
Echoes Of The Past
Fast-forward to 2023, and we’re seeing some unsettling similarities. Recent data reveals signs of inflation acceleration in Germany after three months of deceleration. This re-acceleration of consumer prices, particularly in crucial sectors such as energy and food, indicates more deeply entrenched inflation than previously believed.
It’s worth noting that today’s inflationary climate is global, much like in the 1970s. The interconnectedness of world economies, a byproduct of more than three decades of globalization, suggests we could see periods of inflation re-acceleration in the United States and other nations.
In particular, Germany seems to be entering a second wave of inflation acceleration. Given that U.S. inflation rates have been closely correlated with those in Germany and Europe since the 1970s, this could foreshadow what’s to come in the American economy.
Infaltion, consumer prices for Germany and the United States.
The Challenge Of Wage Growth
One of the key factors that makes moderating inflation difficult in the current economic environment is the high level of wage growth, which still hovers around 5.5%. There’s a strong correlation between wage growth and consumption, especially considering many consumers have low savings.
Reducing wage growth will be crucial to bringing inflation rates sustainably back to the Federal Reserve’s 2% target. However, achieving this may require a recession, as the U.S. labor market has proven to be very resilient and historically tight.
Compensation of employees and personal consumption expenditures.
The Fed’s Stance
The Federal Reserve is well aware of the risks of inflation re-acceleration. Its guidance indicates additional hikes are on the horizon and leaders intend to hold rates high for an “extended period.” This suggests that the Fed also sees wage growth as a vital issue in its fight against inflation.
However, the Fed’s tools to combat inflationary pressures such as wage growth are limited, especially when government spending programs that flow directly into the economy continue. To bring wages and therefore consumption down, the economy must slow dramatically.
Looking ahead, the most considerable risk to a smooth deceleration of inflation is energy prices, which have begun to rise again after moderating in 2022 and early 2023. Since energy impacts so many areas of the economy, when its prices rise, inflationary pressures cascade.
Achieving sustainable control over inflation and bringing it down to lower target levels requires stringent fiscal policy. Simply tracking the consumer price index to forecast what the Fed will do does not account for the complexities of inflationary pressures.
Ultimately, as we examine the current global economic scenario, it’s clear that Americans need to be prepared for the possibility of an inflationary upswing similar to that of the 1970s. Going forward, the labor market and wage growth will be key indicators to monitor and provide the most reliable hints of the path of inflation and progress toward the Fed achieving and sustaining its target rate of 2% inflation.
