Maybe this can stay GQ, but if it drifts and needs to be moved, then that’s fine.
I was watching the 1980 Presidential Debate between Reagan and Anderson–Carter refused to appear for some reason.
Both Anderson and Reagan complained about the high inflation and high interest rates. They also complained about the “shocking” $63 billion budget deficit that year and that the overall debt was approaching $1 trillion.
Anderson proposed some increased social spending which Reagan said that it would add to the deficit causing higher interest rates. The reason being that with the government borrowing $63 Billion, then that is that much less money out there for people and businesses to borrow, causing demand to increase and lenders could get higher interest.
Reagan proposed tax cuts which Anderson argued would raise inflation. The reason being that with more money circulating in the economy, it would be worth less, the classic definition of inflation.
Both disputed their opponents contention, but neither objected to those general thoughts on interest rates and inflation.
Fast forward forty years. The total debt is now $25 trillion, and the deficit during normal times was reaching $1 trillion per year and we just created $2 trillion out of nothing for the stimulus. However, interest rates and inflation remain at historic lows.
Why was the economy so sensitive to higher interest rates and inflation in 1980, but now it seems meaningless. What would cause inflation or higher interest rates? If we printed $10 Trillion or $100 Trillion, would that make a difference?
AFAICT, economists generally consider the high peacetime inflation of the late 20th century to have been an aberration/malfunction due to shortsighted monetary policy decisions that are now generally avoided. So we wouldn’t expect to see similar effects in the current setup. One economist explains:
Keep in mind that the financial structures of the 50s-early 80s were vastly different than they are today. National economies, a greater focus on full employment and wages, etc…
Inflation is too much money chasing too few goods. Yes, we’ve created a lot of additional money, but that money now has effective access to a larger pool of goods (and services, and investments), both domestically and abroad. Also, velocity of money itself has slowed down quite a bit:
Further, a lot of the newly-created money in the past couple of decades has sat idle to a meaningful degree. For example, take Bank Excess Reserves: Excess Reserves of Depository Institutions (DISCONTINUED) (EXCSRESNS) | FRED | St. Louis Fed . This shows that banks, at least in principle, could be issuing far more loans than they currently do, but they choose not to (why this is the case is probably a GD thread in its own right).
All this paints a picture where the increased money supply is not doing a whole lot of chasing.
If you create enough money, at some point it will start to cause inflation. But a lot depends on how you create the money. If you create the money, shove it into the accounts of the various financial institutions, and then the institutions don’t invest/loan the money, then you haven’t really done much at all, inflation-wise. This was quantitative easing during the Great Recession. If you print up a bunch of money and drop it from helicopters, and then people take their found money and go crazy spending it, sure that will probably cause inflation.
The stagflation of the 70s and 80s does seem to be the exception, not the rule: Chart on 5,000 Years of Interest Rates (see Chart 1, originally published by the Bank Of England)
Okay, trying to estimate interest rates in 300 AD is probably a tad silly. But it does lend credence to the notion that the post-WW2 era inflation was an anomaly.
Around the time of that election, interest rates peaked to an astronomical (by our standards) level. I recall people here in Canada (not much different than the USA) facing 21% mortgage rates when it was time to renew. So many simply walked away from their houses that the national mortgage insurance company changed the rules so you could not simply turn in the keys to the bank and walk away.
Macro-economically, the central banks of the western world decided that fighting inflation and high interest rates would be their number one target. But first - that high interest rate plugged the leaky dam of inflation. in the 70s it got to the point where 10% inflation was quickly becoming the norm. Politicians loved this, because debt run up one year was less debt then next year- until everyone figured it out, and wanted higher interest to cover it. Since the mid-80’s central banks have conspired to ensure that the money supply is regulated to reduce inflation. You used to hear whether they would jack up interest rates if inflation seemed to be heating up beyond the 2% to 3% considered acceptable. However, assorted market shenanigans and now the pandemic seem to have defeated the interest rate mechanism. The theory is if the economy slowed down too much, the central banks would lower rates to “prime the pump” and get the economy going. However, we are stuck on the wrong side - interest rates went down but never managed to go up … there’s also the risk that the economy is too fragile - so many loans and mortgages are based on low interest rates, too high a rise could trigger a wave of bankruptcies.
To take as an example a client I just worked on. They got a PPP loan for say, $60,000. They used, say, $10,000 of that to make payroll the next week, and put the other $50,000 into savings for later payroll needs. No more money is available to consumers than there was in the past; the extra $10,000 that was spent on payroll may have come from thin air, but the reason it was needed is that the company hadn’t done enough business to make the $10,000 it normally would. That is, money is not changing hands fast enough for the effects of all the money in the system to be felt. The nature of the crisis causing this economic slowdown means that simply pushing a little more money to get people back onto their feet isn’t enough - we have to keep feeding more and more money to keep things stabilized while the health crisis plays out. It will take a long time for everything to reopen and the conduits for money to move become fully available again, and as that happens the Central Bank can ease off the gas pedal.
In the second debate, only Carter and Reagan were invited. CNN had Anderson in another location and asked him the same questions that were asked of Carter and Reagan, and provided his answers on delay.
There’s a simple reason why neither the U.S. nor the U.K. experienced high inflation (or high interest rates) until the late 1960’s. Examine the series in the Spoiler. 1969 is the first year that the interest rate goes above 6%. Notice anything happening in Column #2?
[SPOILER]Column #1 is year;
Column #2 is the market price of one Troy ounce of gold in New York City — a very poor proxy for CPI but it clarifies a key point;
Column #3 is the yield on 10-year Treasury bonds.
The Treasury yield series starts in 1871, but the £4.24 market price of gold in London in 1871 is essentially the identical price set when Sir Isaac Newton was Master of the Mint in the 1720’s.
A lot of good replies.
Inflation calculation methods have also changed over the years. There are various pressures on governments to make official inflation figures appear as low as possible.
Manufacturing costs have also dropped. For bad reasons in my opinion.
Also in my opinion. Low interest rates have been used to paper over an over extended financial system. Raising them would cause failures of risky/bogus investments. We are trapped in a low interest rate loop. Savers get screwed, borrowers at the higher end of the financial system have to have them. Low or even 0 interest rates promote high risk behaviors. These behaviors now spread terrible risk all through the system.
As was suggested in another post, high persistent inflation with precious metal (or strictly precious metal backed) money is pretty much impossible. The issuers of precious metal coins could debase them and cause inflation; likewise could new sources of the metal. But it was rare for those things to occur at a measured rate over years or decades as with fiat money inflation, debasement or new precious metal supply generally happened in clumps. So there isn’t much validity to inductive observations about how rare problems like the mid 20th century fiat money inflation problem will be in the future by looking at the whole history of money, which was overwhelming precious metal money.
The right answer to the original question is that we don’t know. There is no assurance there won’t be similar episodes in the future. We know that it’s become harder to generate more inflation, but central bankers are trying hard to do that. There’s no gtee it won’t shift to become easier to generate and harder to squelch than seems right now, therefore a new inflation problem. Or not. The future is really hard to predict, even with Google.
What I heard on a Planet Money podcast made a lot of sense to me.
The giants of industry in the 70’s, GM etc, required massive loans to retool their factories every decade or so. With most American manufacturer happening in the US (pre China), the money demand was very high as in was very expensive to build new plants or buy new machinery.
Fast forward to 2020, the largest American companies (Amazon, Google, Facebook) do not make physical products and the need for periodic heavy financing has disappeared.
With a lower demand for money, interest rates are lower.
I am not an economist and I may have oversimplified but its got to be a factor.
