Historical Perspective on Inflation

Written by Richard Hokenson 

Last week’s historical perspective on U.S. long-term interest rates concluded that low interest rates are not unusual. The “new normal” is simply the re-establishment of the “old normal”. What was true for long-term interest rates is also true for CPI inflation. From 1774 to 1940, there was essentially no change in the level of the Consumer Price Index (see Chart 1). There were, of course, many cyclical interruptions in the secular path. Annual CPI inflation reveals several episodes of high inflation rates usually associated with major wars (see Chart 2). But these episodes of high inflation were quickly followed by episodes of deflation, leaving the level of the index essentially unchanged.

That picture began to change post 1940 (see Chart 3). The higher inflation rate due to World War II subsided with a decline in 1949 but was quickly followed by a surge in prices associated with the Korean War. Inflation remained very low (dipping in 1955), only to surge in the 1960s as baby boomers became of working age and the economy was subjected to an everincreasing number of positive demand shocks as more than 4 million baby boomers reached the stage of their life when they are leaving their parent’s home where they share goods and services and beginning their adult life cycle in terms of needing a place to live, a place to work, a place to shop, etc. Inflation, which had been only cyclical for most of its history, now became persistent. It is no mystery that the surge in inflation was then followed by the reestablishment of secular disinflation as smaller generations reached working age (slower growth in positive demand shocks) and ageing more productive baby boomers increased supply.

Most if not all central bankers seem to be tied to the notion that higher inflation is just around the corner. They remember the persistence of inflation of the 1960s and 1970s and treat the current environment as bizarre. What they do not seem to realize, however, is that monetary policy is now highly asymmetrical. Their ability to stimulate, i.e. the ability to produce higher inflation is increasingly compromised by global ageing. Their ability to restrict, however, is enhanced. At the least, it would suggest that movements to withdraw stimulus be done at a very slow pace.

This update was researched and written by Richard Hokenson. Data is as of 5 January 2018

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