As we look at today’s economic landscape, parallels to the inflationary upswing of the 1970s are emerging, 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 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 the present day, 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 that previously believed.
It’s worth noting that today’s inflationary climate is global, much like in the 1970s. The interconnectedness of today’s world economies, a byproduct of over three decades of globalization, suggests that 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.
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 the low savings rates of many consumers.
Reducing wage growth will be crucial to bringing inflation rates sustainably back to the target 2% rate. However, achieving this may require a recession, as the labor market in the U.S. has proven to be very resilient and historically tight.
The Fed’s Stance
The Federal Reserve is well aware of the risks of inflation re-acceleration. Their guidance indicates additional hikes are on the horizon and that they 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 we 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 with be key indicators to monitor and provide the most reliable hints of the path of inflation and progress towards the Federal Reserve achieving and sustaining their target rate of 2% inflation.
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