While there are shortages today, they’re not due to price controls. In fact, inflation and rising wages should eventually cause more production and more people to come back into the labour market. The shortages reflect pandemic-related problems in the supply chains and deliveries, rather than embargoes or boycotts.
The Nixon administration also de-linked the dollar from gold, and the value of the dollar initially fell quite significantly. This boosted the price in dollar terms of all commodities, including energy, as well as goods. Today, in contrast, the dollar is strong and is tending to appreciate, not fall — which should reduce upward pressure on commodity and goods prices.
Moreover — and perhaps most importantly — the U.S. Federal Reserve (Fed) made major mistakes in the 1960s and ’70s. Most important of these was that the Fed repeatedly caved into presidential pressure for easy monetary policy. In 1965, then-U.S. President Lyndon B. Johnson put enormous pressure on the Fed to maintain an easy money policy. It went so far that Johnson reportedly physically attacked Fed Chair William McChesney Martin, throwing him into a wall, when he refused to heed Johnson’s request and instead raised rates. After this attack, the Fed didn’t raise rates again until after Johnson decided not to run for re-election in 1968, but instead tried to use regulation to slow credit growth (albeit with little success).
In 1973, the Fed cut rates under political pressure from then-President Richard Nixon, even though inflation was rising, which helped spur a further acceleration in consumer prices. Nixon infamously said that he respected the Fed’s independence, but expected his Fed Chair, Arthur Burns, to independently draw the same conclusions as him.
Inflation is again a political problem for the Biden administration. In fact, it may be the single biggest problem going into the mid-term elections, with President Joe Biden recently saying that bringing down inflation is his top priority. That gives the Fed another reason to focus more on inflation than on economic growth. An additional reason is that the Fed is starting from a position of extreme accommodation, and so it likely feels more comfortable — and perhaps believes there is a greater need — for normalization of some sort. And so Powell’s Fed could be different than the Burns or Martin Feds, which allowed inflation to run without tightening policy, with the Burns Fed actually easing further.
We expect the Fed will normalize monetary policy by not only tapering asset purchases but accelerating that tapering at its meeting this week. In other words, it is taking a far more proactive stance in tackling inflation. Now I continue to believe there is a much higher hurdle for raising rates, which is appropriate, but that doesn’t mean we won’t see a rate hike by mid-2022 depending on economic conditions.
Conclusion
In short, our view is that stagflation is an extremely unlikely scenario for the U.S. in 2022. But that doesn’t mean that the Fed isn’t concerned about inflation — in fact, moving closer to its “full employment” target means it can focus more on inflation. Navigating the current inflationary environment will not be easy for the Fed. It seems the most appropriate response for the Fed right now should be a relatively neutral policy, neither too loose (to avoid pumping up demand because supply is restricted), nor tight (because that could interfere with investment in raising supply to ease bottlenecks and shortages). And that’s just where the Fed seems to be going now.
