Richard N. Langlois is a professor of economics at the University of Connecticut and the author of The Corporation and the Twentieth Century: The History of American Business Enterprise (Princeton University Press, 2023).
For those of us old enough to remember it, the recent flare-up of inflation calls to mind the Great Inflation of the late 1970s, which came at the foot of a recession. There are indeed similarities between that historic episode and what is happening today.
Economists distinguish between the real economy – how many apples it takes to buy a dozen oranges – and the money economy – how many dollars it takes to buy a dozen oranges. When the value of a dollar gets out of alignment with the value of apples and oranges, we feel it as a recession. In principle, central banks can fix the problem by controlling the supply of dollars.
But when a recession happened in the 1970s, it was far more a crisis of apples and oranges than a crisis of dollars. Western economies were radically reorienting themselves away from the increasingly ill-adapted institutional and organizational structures that had prevailed during the decades of depression and war. The sudden resurgence of foreign competitors began wreaking havoc on bedrock North American industries such as steel, automobiles and consumer electronics. After the Yom Kippur War in 1973, the OPEC cartel altered the relative price of oil dramatically.
The Bank of Canada and the U.S. Federal Reserve responded to the stagnating economy by injecting more dollars into the system. But far from stimulating the economy, these injections merely caused prices to rise. In both Canada and the U. S., the annual rate of inflation would top out at more than 12 per cent. A new piece of vocabulary became necessary: stagflation.
Eventually central banks realized that they were the cause of inflation and cut back dramatically on money creation. The result was a sharp but severe recession, during which interest rates shot through the roof.
We are still living through the effects of the pandemic. Although this episode differs in important ways from the stagflation of the 1970s, including in severity and duration, the economic turmoil of COVID-19 bears one crucial resemblance to the days of stagflation: The pandemic recession was and is a phenomenon of the real economy, not principally the monetary economy.
Seeing the pandemic spread, people retreated from their workplaces to their homes. They purchased fewer goods and services. Economic activity slowed. Harvard economist Greg Mankiw called the downturn an “intentional recession.”
Quite appropriately, governments legislated relief for what was really a natural disaster. Central banks backstopped financial markets. But the banks did more than that: As in the 1970s, they began increasing the money supply.
By late spring of 2020, the Bank of Canada was increasing the money supply at an annual rate of 20 per cent. By 2021, that rate was 30 per cent. The U.S. Fed was doing much the same. As in the 1970s, the result was price inflation. The base Canadian consumer price index (CPI) jumped from an annual growth rate of essentially zero at the height of the pandemic to 8.1 per cent in June of 2022.
Remembering the lessons of the past, central banks have since reduced the growth of the money supply, and inflation is easing. In late summer 2022, the Bank of Canada stopped money growth and, at the end of the year, began decreasing the money supply – at an annual rate of 3.6 per cent in December. By January, CPI growth was down to an annual rate of 5.9 per cent.
Are we living through a second era of stagflation? In a dynamic economy, real relative prices are always churning. But the pandemic was a daunting external shock, and we continue to face major realignments. With the benefit of pandemic-induced improvements in technology, people have learned that frequent office commutes can be unnecessary. Supply chains are only beginning to come back online. The war in Ukraine and fears about trade with China are also wrenching the relative prices of major commodities.
But the other lesson of the stagflation era is that, with a steady hand on the monetary tiller, we can emerge from today’s economic turmoil with the same kind of healthy real growth we saw in the late 20th century.