Lhe United States obviously has a problem with inflation. But we do not yet know what will be the evolution of it or its duration. Worried, some observers draw a parallel with the 1970s, when the prices of energy and raw materials had exploded. The Federal Reserve (Fed) was slow to react, and inflation expectations no longer knew any limit. Producers, consumers and workers expected higher prices to continue or accelerate. As a result, households had adjusted their spending, unions their wage demands and companies their prices, which had triggered an inflationary spiral.
On the other hand, today, inflation expectations remain stable. According to one University of Michigan survey, consumers expect inflation to approach 5.4% this year, then drop to just above 2% over the next four years. Inflation expectations linked to five-year inflation-linked treasury bills shows much the same: it averages 3.4% over the next five years. Given the 5% expectation for 2022, we can deduce that the inflation expectation for the period 2023-2026 is lower than this value. In other words, there is no reason to predict major variations in inflation expectations.
However, as stable as it is at the moment, will it remain so in the future or will it evolve upwards as in the 1970s?
Bretton Woods Consequence
Answering this question involves determining to what extent the conditions that led to the “great inflation” of the 1970s are now, or not, forgotten in history. Let’s not forget that in 1973, when consumer price inflation reached 6%, it made sense for consumers, producers and workers to extrapolate that rate into the future. They believed that inflation would persist, because there was no reason to believe that the Federal Reserve would bring it under control.
The Fed, in any case its leaders, did not even have, at the time, a model of the relationship between monetary policy and inflation. In the 1950s and until the beginning of the 1960s, monetary policy was decided above all within the framework of the international system of Bretton Woods, set up in 1944. Central banks and foreign States could, at the time, exchange their dollars for gold at the price set by the United States, namely 35 dollars per ounce of gold.
You have 55.54% of this article left to read. The following is for subscribers only.