Thursday, September 4, 2008
Yesterday, I started a series of posts looking at economic data spanning the last nine Administrations with a peek at historical income growth. Today, we address inflation.
With regard to the current Administration, fiscal policy (taxes and spending behaviors) only indirectly affects inflation. It is well known in economic theory that deficit spending (spending in excess of tax revenues) can lead to higher inflation, and surplus spending (spending below tax revenues) can lead to lower inflation. Thus, the current Administration's spending policies and support of the central bank's monetary policies (institution in charge of controlling inflation) will exacerbate (Nixon) or reduce (Reagan, Clinton) inflation.
The 1960’s were a period of low, but accelerating, inflation. The era was known for its decade of strong economic growth, where robust domestic demand eventually fed into inflation. Inflation was further exacerbated by spending on the Vietnam War by the John F. Kennedy and Lyndon B. Johnson Administrations.
The 1970’s are infamous for high inflation and the related oil shocks. However, from an economic perspective, the real inflation problem was created by the Nixon price controls. The oil shocks of 1973 and 1979 created inflation surges, but inflation dissipated rather quickly. Richard Nixon colluded with then Fed Chairman, Arthur Burns, to create the worst inflation problem in history. Rather than restricting the money supply to curb the inflation already in place from the 1960’s, Nixon (with the blessing of Burns) enacted price controls that resulted in a precipitous surge in inflation after the controls failed in 1973. The rest of the decade was riddled with problems, and inflation hit its peak of 11.43% in 1979.
In comes Ronald Reagan, who inherited two decades of previous Administrations’ inflation problems. Reagan likely exacerbated inflation with his strong expansionary tax policies, but he supported restrictive monetary policy with the intent of reducing inflation. This is admirable, since measures to curb inflation often result in a recession and likely ousting of the current Administration. Nevertheless, Reagan recognized the seriousness of the inflation escalation, and at the risk of losing a second term, supported Paul Volcker’s famed disinflationary policy.
Early on, the 1990’s were plagued by the Gulf War, which created a shock to the world oil markets and inflation. However, the 1990’s are generally known as a period of low and stable inflation, driven by record productivity growth, smart monetary policy, and reduced budget deficits. I will concur that Clinton’s objective to balance the budget definitely played its part in reducing inflation, but as I stated yesterday, raising taxes is much easier when the economy goes through a 10-year expansionary phase.
Finally, we have the recent bat of inflation, which many will blame on Geroge W. Bush. However, strong global growth and tight oil supplies are the real culprits. On the upside, July’s 5.6% annual inflation rate is unlikely to hold throughout 2008. Oil prices are 20% off their peak, driven down by a US-led global slowdown; inflation is set to abate with energy prices, and the next Administration will inherit low inflation.
However, ongoing stable inflation depends on sound monetary policy and tight fiscal policy (keeping spending in check). Only time will tell whether both of those objectives can be attained. However, I do not see how a Democratic Congress plus a Democratic Administration will result in tight fiscal policy. If the country elects Obama as President, get ready for a spending ride that will result in building inflation.