Inflation and pay restraint
In economic terms, the 1970s was the decade of stagflation, a period in which the rules of the economic game were turned upside down. It was the decade when economists discovered it was possible to have a combination of high inflation and rising...
In economic terms, the 1970s was the decade of stagflation, a period in which the rules of the economic game were turned upside down. It was the decade when economists discovered it was possible to have a combination of high inflation and rising unemployment. The Keynesian demand management consensus of earlier decades began to fall apart. In the attempt to reduce unemployment, policymakers found inflation rising further and further.
This, though, is merely a description of events. What really went wrong? One conventional view is that in the UK, for example, the 1970s were a decade of excessive union power. Industrial relations rapidly deteriorated and union leaders, following their own political agendas, held the country to ransom.
There is, of course, some truth in this story. But it is not the whole truth. The rebelliousness of unions in the early 1970s was, in part, a response to hopeless macro-economic policies which led the government of the time to impose a prices and incomes policy. The unions may have had their own agendas, but they were helped along by a government which had a very poor grasp of economic reality.
During the 1970s inflation was a global problem: prices were rising rapidly on both sides of the Atlantic. To suggest, then, that unions were solely responsible for Britain's inflationary scourge does not really ring true. All major industrialised countries had their inflation difficulties, whether or not their unions were militant.
The source of 1970s inflation was a combination of factors in the late 1960s. First, the Americans wanted to fund the Vietnam War, and were happy to print dollars to do so. Second, in the process of printing dollars the Americans undermined the prevailing monetary framework, which for most countries was the Bretton Woods exchange rate system. Third, governments lost the support of the people, with anti-war sit-ins, race protests and, in Paris, student riots all adding to a sense of deep popular unease. By the end of 1971 the Bretton Woods exchange rate system was more or less in tatters, with the Smithsonian Agreement merely a last-ditch attempt to maintain the old order. The dollar's value against gold was no longer secure. Other countries were no longer sure that a dollar peg was any longer in their own national interests. They went their separate ways.
Freed from the exchange rate constraint, the UK decided to go for growth. This led to an extraordinary surge in growth which, some believed, would somehow create its own additional capacity.
It was not until the end of 1973, after the Yom Kippur War, that the world received its first major oil shock as a result of the Arab oil embargo, long after inflation had started to head upwards. The quadrupling of oil prices merely added fuel to the fire.
The year 1979 brought a series of new challenges. The Iranian revolution, signalling both a further doubling of oil prices and the emergence of Islamic fundamentalism, sent shockwaves through the world. Paul Volcker, the new chairman of the Federal Reserve, showed he was prepared to throw the US economy into recession to deal with inflation.
The lesson from all of this is not so much that we can feel cheerful in the knowledge that union power is a thing of the past. Instead, we discovered in the 1970s that economies simply do not work well with an absence of monetary discipline. Inflation is evil primarily because of its apparently arbitrary creation of winners and losers.
The question, therefore, is whether the monetary systems now in place are more robust than those which dominated the economic landscape in the late 1960s and early 1970s. In a large part of the world - the emerging markets - they are not. Some emerging economies, of course, pay lip-service to inflation targeting, but the commitment is typically not really there. For the rest of us, inflation targeting is only now facing its first true test. As raw material prices rise, will we really stand idly back as wages and profits are squeezed in order to meet existing inflation targets? Or, instead, will those targets be abandoned?
Workers pushed for inflationary wage increases in the 1970s not because they desired higher inflation but because they were not sure of their real spending power in an inflationary world. In the early 1970s the loss of confidence in price stability was a huge contributory factor behind the emergence of far greater wage pressures. It is, therefore, vital now that central banks preserve that confidence.
• This report was compiled by the Marketing Department of HSBC Bank Malta plc on the basis of economic research and financial information produced by HSBC International Bank.
This, though, is merely a description of events. What really went wrong? One conventional view is that in the UK, for example, the 1970s were a decade of excessive union power. Industrial relations rapidly deteriorated and union leaders, following their own political agendas, held the country to ransom.
There is, of course, some truth in this story. But it is not the whole truth. The rebelliousness of unions in the early 1970s was, in part, a response to hopeless macro-economic policies which led the government of the time to impose a prices and incomes policy. The unions may have had their own agendas, but they were helped along by a government which had a very poor grasp of economic reality.
During the 1970s inflation was a global problem: prices were rising rapidly on both sides of the Atlantic. To suggest, then, that unions were solely responsible for Britain's inflationary scourge does not really ring true. All major industrialised countries had their inflation difficulties, whether or not their unions were militant.
The source of 1970s inflation was a combination of factors in the late 1960s. First, the Americans wanted to fund the Vietnam War, and were happy to print dollars to do so. Second, in the process of printing dollars the Americans undermined the prevailing monetary framework, which for most countries was the Bretton Woods exchange rate system. Third, governments lost the support of the people, with anti-war sit-ins, race protests and, in Paris, student riots all adding to a sense of deep popular unease. By the end of 1971 the Bretton Woods exchange rate system was more or less in tatters, with the Smithsonian Agreement merely a last-ditch attempt to maintain the old order. The dollar's value against gold was no longer secure. Other countries were no longer sure that a dollar peg was any longer in their own national interests. They went their separate ways.
Freed from the exchange rate constraint, the UK decided to go for growth. This led to an extraordinary surge in growth which, some believed, would somehow create its own additional capacity.
It was not until the end of 1973, after the Yom Kippur War, that the world received its first major oil shock as a result of the Arab oil embargo, long after inflation had started to head upwards. The quadrupling of oil prices merely added fuel to the fire.
The year 1979 brought a series of new challenges. The Iranian revolution, signalling both a further doubling of oil prices and the emergence of Islamic fundamentalism, sent shockwaves through the world. Paul Volcker, the new chairman of the Federal Reserve, showed he was prepared to throw the US economy into recession to deal with inflation.
The lesson from all of this is not so much that we can feel cheerful in the knowledge that union power is a thing of the past. Instead, we discovered in the 1970s that economies simply do not work well with an absence of monetary discipline. Inflation is evil primarily because of its apparently arbitrary creation of winners and losers.
The question, therefore, is whether the monetary systems now in place are more robust than those which dominated the economic landscape in the late 1960s and early 1970s. In a large part of the world - the emerging markets - they are not. Some emerging economies, of course, pay lip-service to inflation targeting, but the commitment is typically not really there. For the rest of us, inflation targeting is only now facing its first true test. As raw material prices rise, will we really stand idly back as wages and profits are squeezed in order to meet existing inflation targets? Or, instead, will those targets be abandoned?
Workers pushed for inflationary wage increases in the 1970s not because they desired higher inflation but because they were not sure of their real spending power in an inflationary world. In the early 1970s the loss of confidence in price stability was a huge contributory factor behind the emergence of far greater wage pressures. It is, therefore, vital now that central banks preserve that confidence.
• This report was compiled by the Marketing Department of HSBC Bank Malta plc on the basis of economic research and financial information produced by HSBC International Bank.