Stop comparing today’s inflation with the 1970s

Economist Richard Holden believes Australia won’t experience 1970s style stagflation (i.e. low economic growth and high inflation) because the Reserve Bank of Australia (RBA) won’t let it happen and will aggressively hike rates before any wage-price spiral could take effect:

If people expect higher inflation, they will try to raise prices or demand higher wages. In fact, they will try to do that to protect their real purchasing power. So, a 1 per cent increase in inflation expectations will manifest itself in 1 per cent higher rate of actual inflation.

The lesson was unmistakeable: central bankers need to keep inflation expectations under control. With those expectations out of control in the late ’70s, bold action was required.

When Volcker became Fed chairman, he was determined to do whatever it took to bring inflation under control… And Volcker’s approach worked. Inflation was brought down in the US from about 13 per cent in 1980 to about 4 per cent in 1982.

In a perfect confluence of theory-meets-practice, economists around the world learnt the lesson that stable inflation expectations are the key to effective monetary policy. The RBA was no exception in this regard, adopting a formal inflation target in 1992.

The main reason we are unlikely to have 1970s-style stagflation is because the RBA won’t let it happen. It knows how to avoid it, and it will do whatever it takes.

And because it is independent of government, there will be no political meddling to stop it.

The reason why Australia won’t experience 1970s-style inflation is not because of the actions of the RBA, but because the institutional settings are wildly different.

Centralised wage fixing ended decades ago. As such, the power imbalance against workers is simply too great to ever create a 1970s-style wage price spiral.

Back then, the majority of Australian workers were unionised. Today, less than 15% of workers are in a union.  De-unionisation, insecure work, deregulation of the wage-setting process, and the immigration system have worked together to shift the balance of power away from workers. Accordingly, the share of national income going to profits has hit an all-time high, whereas workers’ share of income has plunged. Again, this is the polar opposite from the 1970s, as illustrated clearly below:

Share of total factor income

Australian workers neutered.

Richard Holden may also want to read a recent study from the Federal Reserve (summarised here), which “suggests that the impact of the “Volcker shock” has been vastly overplayed, and that the inflation of the 1970s was solved through de facto class war and the degradation of the union movement rather than monetary policy”:

On their understanding, inflation isn’t due to a lack of credible commitment from central banks to control inflation, but a power struggle between capital and labour… Its engine is likely to be a battle between capital — who seeks to maintain its share of national income via mark-ups — and labour, who try and do the same through higher wages…

What does this mean for central banks? If sustained inflation derives from class war, then the chances of the current bout becoming entrenched again are extremely low.

The working class as a cohesive social force no longer exists. Businesses can safely protect their margins and the burden of inflation will fall on labour as real wages fall. Sustained price rises will eventually subside as supply shocks from the pandemic and war fade and real spending power is eroded…

In other words, inflation will subside, not because it’s necessarily transitory, but because workers don’t have the power to make it stick around.

In any event, if Richard Holden is worried about domestic inflation, he should go after businesses that continually jack up prices to juice their profits.

He should also demand East Coast gas reservation and coal/gas export controls and super profits taxes to delink Australian energy prices from the global market. This would have far more impact in reducing inflationary pressures than bluntly hiking interest rates and smashing the economy.

Given most of Australia’s inflationary pressures are either imported or weather related, hiking interest rates will do little to resolve them anyway.

Unconventional Economist
Latest posts by Unconventional Economist (see all)

Comments are hidden for Membership Subscribers only.