The world economy has a good chance of avoiding a full-blown repeat of 1970s-style stagflation, and that’s the good news.
A historic surge in commodity prices following Russia’s invasion of Ukraine, on top of already high pandemic inflation, has prompted investors and economists to look for parallels to the energy shocks four decades ago and the protracted slowdowns that followed.
They’re right to worry, says Maurice Obstfeld, former chief economist at the International Monetary Fund.
“The longer this period of protracted shocks lasts,” he said, the more likely economies will suffer “something like the 1970s experience.”
Among developed economies, risk is perhaps greatest in the euro area. The European Central Bank unexpectedly said last Thursday that it will speed up the unwinding of monetary stimulus as inflation has already nearly tripled its target.
“That is the biggest risk that we could repeat the experience of the 1970s,” Otmar Issing, the ECB’s first chief economist, told Bloomberg Television. “And that’s the worst combination for a central bank.”
All in all, most economists believe that history is still avoidable. But their reasons for doing so are not necessarily encouraging for companies and workers.
Weaker economic growth and perhaps even a recession could be the price of beating inflation, with emerging markets being particularly vulnerable.
“We should be more concerned about a significant slowdown in global economic growth” than about runaway inflation, said Kazuo Momma, formerly head of monetary policy at the Bank of Japan.
That’s partly because central banks like the US Federal Reserve have learned lessons from the sustained inflation of the 1970s — enough not to retrace that “dark path,” according to Mark Zandi, chief economist at Moody’s Analytics.
“They would rather push us into recession sooner than into the stagflation scenario and a much worse recession later,” says Zandi.
Another important reason why economists don’t expect a rebound in the 1970s is that workers can no longer negotiate their wages as they did then.
Unions have shrunk dramatically in the US and UK. Even in Germany, where they play a larger role, there is currently caution about pushing for large wage increases.
This means that the so-called wage-price spiral that drove the inflationary episode of the 1970s is less likely to repeat itself. Households are also at risk of a major shortage as incomes cannot keep up with higher prices in supermarkets or gas stations.
There are still reasons to leaf through the history books. The 1970s saw two energy spikes related to the 1973 OPEC oil embargo and the Iranian Revolution six years later.
In the weeks since Russian President Vladimir Putin ordered troops into Ukraine, the cost of crude oil has soared to over $130 a barrel – amid a much wider range of price jumps. Russia is a major producer of commodities ranging from wheat and fertilizers to nickel, and US-led sanctions have hit these markets.
In both the 1970s and today, the shocks hit economies that were already struggling with inflation. For example, data released last Thursday showed that the US consumer price index rose 7.9% in February, the sharpest rise in 40 years. Bloomberg Economics sees a peak of around 9% in March or April
There were also several sources of inflation. The 1970s saw the move away from the gold standard, leading to dollar devaluation and the hangover of the 1960s stimulus programs. Even the Peruvian anchovy, a key ingredient in livestock feed, played a role when, in 1972, a slump in catches caused by the El Nino weather pattern pushed up feed and beef prices.
Over the past year, Covid-19’s legacy of frayed utility lines, high government spending and loose monetary policy ignited prices. Europe faced an energy crisis even before the Russian invasion.
One difference is that developed economies are much less energy intensive than they were then.
“Oil consumption as a percentage of GDP is much lower and energy efficiency has improved,” says Paul Donovan, chief global economist at UBS Wealth Management.
And it’s not just about energy: “We’re also much less resource-intensive.
Nevertheless, some of these numbers could shift in the current crisis.
In Europe, which gets most of its oil and gas from Russia, the “energy cost burden” on the economy is probably the highest since the 1970s, according to Alex Brazier, a former Bank of England official who is now an executive director at BlackRock investment institutions.
The recent spate of commodity-driven price hikes presents an even more difficult balancing act for central bankers, who must juggle the risks of persistent inflation and growth slowing or reversing.
At least in the US, investors still expect the Fed to raise interest rates by six quarter points this year, starting next week. Economists at Citigroup predict the central bank will eventually make a half-point hike.
Relying on the Fed to rein in prices can cause unnecessary economic damage, said Isabella Weber, an economist at the University of Massachusetts Amherst. She said there should at least be a serious talk about government controls on the prices of essential goods.
This proposal drew a backlash from orthodox economists when Weber first made it in December, partly because of the reminder of price controls in the US in the 1970s. But she said the case is even stronger now that food and energy prices are rising.
There are signs that key decision-makers in government and beyond are anxious not to repeat the mistakes of the 1970s by spiking prices and wages.
In the US, President Joe Biden has warned companies against gouging. Announcing a ban on Russian oil imports, Biden said his administration would scrutinize the gasoline industry for signs of “excessive price increases or profit padding.”
On the wage side, bargaining power in some countries – such as the US and UK – has declined so much since the 1970s that workers have little leverage in bargaining. Germany, where unions remain relatively strong, offers a telling example of some lessons.
After the 1973 oil shock, unions responded to nearly 8% inflation by pushing through double-digit wage increases. That helped plunge the economy into its worst slump since World War II — effectively ending full employment.
Unions and employers are now turning to the government for help. IG Metall, Germany’s largest trade union, and the employers’ association, Gesamtmetall, advocated a “comprehensive package of measures” to compensate for inflation in a March 4 statement.
Other countries like France and Spain are also using fiscal policy to cushion the inflation shock by providing subsidies to help households with higher inflation bills. Some economists also support a similar approach in the US.
All of this is resulting in a world economy that is more resilient than it was in the 1970s, according to Christopher Smart, chief global strategist at Barings. He reckons that any period of stagflation will likely be brief.
Still, he says, Russia’s invasion of Ukraine has “created a real crisis that will last for years and maybe decades.”