The End of the Age of Inflation
By Robert J. Samuelson
The Washington Post
Wednesday, August 28, 2002; Page A23
The Age of Inflation is ending the way it began: quietly. Along with the Cold War, the rise and fall of inflation has been a defining event of the present era -- but one that is overlooked, because inflation receded so gradually that almost no one appreciates its historic significance. For four decades, Americans rode the inflation roller coaster up and down with huge economic, political and social consequences. It shaped how we live, affecting everything from the rise of political conservatism to yesterday's stock market frenzy and today's housing boom.
The inflation roller coaster, as measured by the consumer price index, proceeded from a meager 1.4 percent in 1960 to a peak of 13.3 percent in 1979 and then coasted down. In 2001, it was 1.6 percent. On the way up, Ronald Reagan's election in 1980 -- a pivotal political moment -- stemmed heavily from an anti-inflation backlash. People despaired at the double-digit onslaught, which disrupted all sense of order and predictability in everyday life. No one could know from week to week the prices of food, clothing or almost anything.
Lenin once said that "the way to crush the bourgeoisie [the middle class] is to grind them between the millstones of taxation and inflation." In America, that process discredited government, which people blamed for inflation's ravages.
The period of the weakest gains in wages and living standards also roughly coincided with the period of highest inflation. By making companies harder to manage, inflation stunted productivity and income growth. Similarly, quelling inflation was an ugly business. Interest rates were raised to stratospheric levels, creating vast pools of unemployed workers and surplus production capacity to beat down wage and price increases. The U.S. recessions of 1973-75 and 1981-82 were the worst since World War II and spread to the rest of the world. In 1982 and 1983, American unemployment averaged almost 10 percent.
One reason inflation is forgotten is the passage of time. About 30 percent of Americans weren't alive in 1980, the era of double-digit price increases. Even today's 35-year-olds were only 13. They barely remember. But another reason is that people don't recognize that inflation's decline has been almost as powerful as its rise.
On the way down, it has been a tonic. Witness the continuing housing boom. Lower inflation has reduced mortgage interest rates to levels not seen since the 1960s. In 2001, mortgage lending totaled a record $2 trillion, according to the Mortgage Bankers Association. About half was mortgage refinancings -- replacing old loans with new loans at lower rates. People reduce monthly payments or borrow against higher housing prices. In an otherwise weak economy, low rates have helped sustain home buying and consumer spending.
Earlier, inflation's descent created the greatest bull market, promoting the spread of stock ownership and leading, in the end, to the speculative follies of the late 1990s. For almost two decades, rising inflation punished the market. In 1982, the Dow Jones industrials averaged 884.36, which was actually lower than in 1965 (910.88). Confidence ebbed; profits suffered. High interest rates sucked savings into bonds, bank deposits and money-market mutual funds. But once inflation subsided, the process reversed. Confidence and profits revived. Interest rates dropped. Money returned to the market.
For the next 17 years, stocks increased relentlessly. Even by 1993, the Dow had quadrupled from its 1982 level to more than 3500. It was this steady rise that fueled popular fervor. No one wanted to be the last sucker to stay out of the market. Sometime in 1997 or 1998, a healthy advance turned into a self-destructive mania obsessed with tech stocks and the "new economy."
The end of the Age of Inflation does not mean that prices will never rise again. Indeed, inflation in some sectors (health care, education) remains maddeningly stubborn. But it does mean that the period of huge swings -- up and down -- and their momentous side effects is over. There's a consensus that high inflation is bad and cannot be condoned. This poses a question: What comes next?
Economically, two broad possibilities suggest themselves. One is optimistic. It envisions greater economic stability. Because high inflation bred instability -- leading to stop-go policies of easy and tight credit -- its demise implies fewer and milder recessions. This has certainly been the experience since 1982 after double-digit inflation was subdued. By historical standards, the 1990-91 recession was tame. For all the complaining, the same has been true (so far) of the latest downturn.
A grimmer possibility is that new instabilities are emerging. The fallout from the stock market "bubble" and the tech boom may hobble the economy for years. The global economy may be inherently weak, because Japan and Europe are incapable of healthy expansion, and "emerging market" countries are vulnerable to currency crises. Deflation -- falling prices that would create a profits squeeze -- could result from worldwide industrial overcapacity and feeble demand.
Who knows?
Easier to explain is the Age of Inflation. It resulted from a well-intentioned intellectual mugging. Disciples of British economist John Maynard Keynes (1883-1946) argued that governments could, through the shrewd manipulation of budgets and interest rates, reduce unemployment and eliminate recessions, with only a tiny rise of inflation. They were wrong, but their recommended budget deficits and easy-credit policies -- once adopted -- created a wage-price spiral and inflationary expectations. Believing government would tolerate inflation, workers and companies had little reason to curb wage and price increases. Only decades later have these expectations been finally purged.
Unwittingly, Keynes provided a fitting epitaph. "Practical men, who believe themselves to be quite exempt from any intellectual influences," he once wrote, "are usually the slaves of some defunct economist." So it was.
© 2002 The Washington Post Company
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