I have finally hit that big birthday and joined the over 50s club. I thought it worthwhile to write a blog comparing the UK economy now with that 50 years’ ago, as some economic commentators fear that we are heading towards a repeat of the 1970s.
High interest rates, high inflation and rubbish piled high
What really characterised the 1970s was a period of high interest rates, high inflation, low GDP growth, strikes and streets filled with rubbish. When I say high interest rates, I mean rates as high as 15%! Even worse was inflation, which peaked in 1975 at a massive 24%. Meanwhile, GDP during the various years in the 1970s was negative or close to zero.
In 1973, the UK was hit by an oil crisis that sent the cost of oil soaring. Firms started to lay off workers and wages didn’t rise to keep pace with rocketing inflation. The country experienced ‘stagflation’ – rising inflation, rising unemployment and slowing growth all at the same time. In 1978, a wage dispute between Labour Prime Minister, James Callaghan, and the unions culminated in the Winter of Discontent. Streets were lined with litter and some dead went unburied, as everyone from dustbin men to grave diggers and nurses went out on strike.
What has happened since then is that interest rates and inflation have continued to fall to the low levels that we have seen now for quite a while. Recently, however, we have started to see some significant changes.
A fast economic recovery followed the first major wave of the pandemic, which has caused bottlenecks in supply chains, labour shortages and inflation supported by accommodative government and central bank policies. Growth in the money supply has soared. UK firms are reporting levels of material, components and labour shortages. Rising inflation is, once again, bidding up wages. All of this is a repeat of how our economy looked back in the 1970s.
So are we going to have to wear flares and get a perm?
I would find one improbable, the other impossible.
In my view, I think we are probably not about to repeat the 1970s due to a number of differences.
- Firstly, the global economy and markets are more open, flexible and competitive today. Exchange rates in most countries are not fixed, so can act as shock absorbers. Worker bargaining power is weaker and labour is less unionised now, so their ability to influence wage increases is less. Financial markets have been deregulated and so are more flexible and open, and can better deal with price increases. Globalisation has increased significantly in the last 50 years. Business is more exposed to international competition particularly through the internet, and individual companies have less pricing power than in the 1970s.
- Secondly, in contrast to the 1970s, Western central banks today are independent of governments, with mandates to ensure low inflation. By contrast, in the 1970s monetary policy was set by governments in most European countries, and with the Federal Reserve there was a focus on growth over controlling inflation. Although central banks have purchased government bonds on a very large scale, they remain credible with financial markets, but more importantly are keen to avoid a repeat of the 1970s.
- Finally, the nature of the energy price shock is different to those of the 1970s. Oil prices were driven by extreme action by OPEC. The shortage of energy inputs pushed inflation higher and restrained production. Today, high energy prices reflect strong demand as the global economy is recovering from Covid. However, international institutions, including OPEC, expect supply and demand to be more in balance in 2022, which should help lead to a moderation in prices.
To a degree, whether or not I am right depends on the belief that central banks can control inflation. If inflation expectations increase, this could lead to increases in wages, which itself is then a self-fulfilling prophecy. These increases could then become entrenched. On the flipside, if banks do control inflation by tightening policy, they run the risk of pushing economies into a recession. There is clearly a fine balancing act that the central banks have to follow, which will be very dependent on data that transpires over time.