Economics / History

Revisiting the Wage-Price Spiral (Part of the Turn to Disinflation Series)

After writing (and rewriting) my previous post, I went back and reread Matthew O’Brien.  I suddenly remembered that his focus was 1979…and I had decided to correct him on the economic history of 1970-74.  But then I saw it again:

This cycle of ever-rising prices got going with too loose monetary policy, and continued with the oil shocks. The former started when Richard Nixon pressured Fed Chair Arthur Burns into lowering rates in the runup to the 1972 election, and the latter turned commodity inflation into wage inflation due to widespread cost-of-living-adjustment contracts. It wasn’t until Jimmy Carter appointed Paul Volcker to run the Fed in 1979 that things began to turn around. After unsuccessfully trying to target the money supply, Volcker decided to jack up interest rates, and keep them there, until inflation came down. It worked.

I was right to focus on the early ’70s—O’Brien claims the inflation was triggered by Arthur Burn’s loose monetary policy in 1972.  Again, I find the evidence lacking.  I revisited O’Brien partly in response to Matthew Yglesias’ arrogant pronouncement:

When Paul Volcker came around and accepted responsibility for the problem, the adjustment turned out to be quite painful. But it wasn’t logistically difficult to pull off, it didn’t take very long, and all things considered we would have been a lot better off deflating in 1973-75 than waiting all the way until 1980-82.

I’ve got news for you, Mr. Yglesias…

U.S. inflation

Year Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Annual
1973 3.65 % 3.87 % 4.59 % 5.06 % 5.53 % 6.00 % 5.73 % 7.38 % 7.36 % 7.80 % 8.25 % 8.71 % 6.16 %
1974 9.39 % 10.02 % 10.39 % 10.09 % 10.71 % 10.86 % 11.51 % 10.86 % 11.95 % 12.06 % 12.20 % 12.34 % 11.03 %
1975 11.80 % 11.23 % 10.25 % 10.21 % 9.47 % 9.39 % 9.72 % 8.60 % 7.91 % 7.44 % 7.38 % 6.94 % 9.20 %
1976 6.72 % 6.29 % 6.07 % 6.05 % 6.20 % 5.97 % 5.35 % 5.71 % 5.49 % 5.46 % 4.88 % 4.86 % 5.75 %

The United States did deflate (or the more appropriate term, disinflate) in the mid-’70s– namely in 1975 and 1976.  News flash: it didn’t work.

Chicken or the Egg?

Going back to Matthew O’Brien, I and at least one prominent economist read “turned commodity inflation into wage inflation due to widespread cost-of-living-adjustment contracts” and thought wage-price spiral.  But wait—what is the wage-price spiral?  According to Investopedia:

The wage-price spiral suggests that rising wages increase disposable income, thus raising the demand for goods and causing prices to rise. Rising prices cause demand for higher wages, which leads to higher production costs and further upward pressure on prices.

So, wages increase inflation, which causes consumer prices to rise, which leads to more wage hikes and spiraling inflation.  Or does it?

Table 1

WAGE GROWTH AND EMPLOYMENT BY WAGE PERCENTILE

1940-90

Real Wage Growth

Percentile

1940-50

1950-60

1960-70

1970-80

1980-90

11-20

.315

.278

.192

-.015

-.169

21-40

.277

.292

.207

.015

-.116

41-60

.197

.301

.232

.073

-.072

61-80

.127

.302

.252

.096

-.024

81-90

.091

.300

.284

.089

.011

1-100

.194

.297

.241

.050

-.078

From Chinhui Juhn and Kevin Murphy’s table (above), the wage-inflation correlation seems, well, lacking:

File:US Historical Inflation.svg

It appears that the immense income gains of the 1950s and 1960s accompanied historically low inflation.  I suppose that might be why there is economic controversy surrounding the concept of the wage-price spiral:

The wage-price spiral is one concept that deals with the causes and consequences of inflation, and it is most popular in Keynesian economic theory.  It is also known as the “cost-push” origin of inflation. Another cause of inflation is known as “demand-pull” inflation, which monetary theorists believe originates with the money supply.

I’m beginning to think this is more semantic than anything else–couldn’t all this be boiled down to a simple theory that inflation causes both wages and consumer prices to rise simultaneously?  Question: does it really matter?  Both theories ignore the 800-lb gorilla in the room.  Having written for months about the 1970s stagflation, I noticed that the most prominent source of inflation historically is almost invariably omitted:

Year Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Annual
1915 1.00 % 1.01 % 0.00 % 2.04 % 2.02 % 2.02 % 1.00 % -0.98 % -0.98 % 0.99 % 0.98 % 1.98 % 0.92 %
1916 2.97 % 4.00 % 6.06 % 6.00 % 5.94 % 6.93 % 6.93 % 7.92 % 9.90 % 10.78 % 11.65 % 12.62 % 7.64 %
1917 12.50 % 15.38 % 14.29 % 18.87 % 19.63 % 20.37 % 18.52 % 19.27 % 19.82 % 19.47 % 17.39 % 18.10 % 17.80 %
1918 19.66 % 17.50 % 16.67 % 12.70 % 13.28 % 13.08 % 17.97 % 18.46 % 18.05 % 18.52 % 20.74 % 20.44 % 17.26 %
1919 17.86 % 14.89 % 17.14 % 17.61 % 16.55 % 14.97 % 15.23 % 14.94 % 13.38 % 13.13 % 13.50 % 14.55 % 15.31 %
1920 16.97 % 20.37 % 20.12 % 21.56 % 21.89 % 23.67 % 19.54 % 14.69 % 12.36 % 9.94 % 7.03 % 2.65 % 15.90 %

And:

Year Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Annual
1941 1.44 % 0.71 % 1.43 % 2.14 % 2.86 % 4.26 % 5.00 % 6.43 % 7.86 % 9.29 % 10.00 % 9.93 % 5.11 %
1942 11.35 % 12.06 % 12.68 % 12.59 % 13.19 % 10.88 % 11.56 % 10.74 % 9.27 % 9.15 % 9.09 % 9.03 % 10.97 %
1943 7.64 % 6.96 % 7.50 % 8.07 % 7.36 % 7.36 % 6.10 % 4.85 % 5.45 % 4.19 % 3.57 % 2.96 % 6.00 %
1944 2.96 % 2.96 % 1.16 % 0.57 % 0.00 % 0.57 % 1.72 % 2.31 % 1.72 % 1.72 % 1.72 % 2.30 % 1.64 %
1945 2.30 % 2.30 % 2.30 % 1.71 % 2.29 % 2.84 % 2.26 % 2.26 % 2.26 % 2.26 % 2.26 % 2.25 % 2.27 %
1946 2.25 % 1.69 % 2.81 % 3.37 % 3.35 % 3.31 % 9.39 % 11.60 % 12.71 % 14.92 % 17.68 % 18.13 % 8.43 %
1947 18.13 % 18.78 % 19.67 % 19.02 % 18.38 % 17.65 % 12.12 % 11.39 % 12.75 % 10.58 % 8.45 % 8.84 % 14.65 %
1948 10.23 % 9.30 % 6.85 % 8.68 % 9.13 % 9.55 % 9.91 % 8.89 % 6.52 % 6.09 % 4.76 % 2.99 % 7.74 %

And:

Year Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Annual
1950 -2.08 % -1.26 % -0.84 % -1.26 % -0.42 % -0.42 % 1.69 % 2.10 % 2.09 % 3.80 % 3.78 % 5.93 % 1.09 %
1951 8.09 % 9.36 % 9.32 % 9.32 % 9.28 % 8.82 % 7.47 % 6.58 % 6.97 % 6.50 % 6.88 % 6.00 % 7.88 %
1952 4.33 % 2.33 % 1.94 % 2.33 % 1.93 % 2.32 % 3.09 % 3.09 % 2.30 % 1.91 % 1.14 % 0.75 % 2.29 %
1953 0.38 % 0.76 % 1.14 % 0.76 % 1.14 % 1.13 % 0.37 % 0.75 % 0.75 % 1.12 % 0.75 % 0.75 % 0.82 %

These are every recorded period where inflation climbed above 9% in American history before 1970 (the eighteen and nineteenth century aren’t available–official records start in 1914).  American inflationary periods in the 20th century in every case prior to Vietnam occurred during wartime or were related to war’s aftereffects.  Yet common wisdom holds that this inflationary period was wage induced:

Year Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Annual
1965 0.97 % 0.97 % 1.29 % 1.62 % 1.62 % 1.94 % 1.61 % 1.94 % 1.61 % 1.93 % 1.60 % 1.92 % 1.59 %
1966 1.92 % 2.56 % 2.56 % 2.87 % 2.87 % 2.53 % 2.85 % 3.48 % 3.48 % 3.79 % 3.79 % 3.46 % 3.01 %
1967 3.46 % 2.81 % 2.80 % 2.48 % 2.79 % 2.78 % 2.77 % 2.45 % 2.75 % 2.43 % 2.74 % 3.04 % 2.78 %
1968 3.65 % 3.95 % 3.94 % 3.93 % 3.92 % 4.20 % 4.49 % 4.48 % 4.46 % 4.75 % 4.73 % 4.72 % 4.27 %
1969 4.40 % 4.68 % 5.25 % 5.52 % 5.51 % 5.48 % 5.44 % 5.71 % 5.70 % 5.67 % 5.93 % 6.20 % 5.46 %
1970 6.18 % 6.15 % 5.82 % 6.06 % 6.04 % 6.01 % 5.98 % 5.41 % 5.66 % 5.63 % 5.60 % 5.57 % 5.84 %
1971 5.29 % 5.00 % 4.71 % 4.16 % 4.40 % 4.64 % 4.36 % 4.62 % 4.08 % 3.81 % 3.28 % 3.27 % 4.30 %
1972 3.27 % 3.51 % 3.50 % 3.49 % 3.23 % 2.71 % 2.95 % 2.94 % 3.19 % 3.42 % 3.67 % 3.41 % 3.27 %
1973 3.65 % 3.87 % 4.59 % 5.06 % 5.53 % 6.00 % 5.73 % 7.38 % 7.36 % 7.80 % 8.25 % 8.71 % 6.16 %
1974 9.39 % 10.02 % 10.39 % 10.09 % 10.71 % 10.86 % 11.51 % 10.86 % 11.95 % 12.06 % 12.20 % 12.34 % 11.03 %

Or due to loose monetary policy.  Whatever.  Perhaps because inflation did not rise above 9% during the course of the Vietnam War, the conflagration in Southeast Asia could not possibly be responsible for the inflationary shock that commenced three months after the war concluded.

You Only Die Once

I surmise that Vietnam was divorced psychologically from the stagflation that followed because three recessions would afflict us before inflation would subside.  Slaying the inflation of past wars required only a single recession.

Inflation during the Great War was more or less ignored until after the armistice.  Out-of control prices following World War I required the horrid Depression of 1921.

World War II ushered in price controls under the banner of the Office of Price Administration (OPA) and much lesser-known War Production Board (WPB) in 1942.  After the WPB was disbanded in 1945, the OPA was left alone to tamp down the postwar inflation.  Failing utterly, OPA was disbanded in 1947 and the recession of 1948-49 wrung inflation out of the system.

Korea’s inflation was battled by the Office of Price Stability (OPS) before being disbanded by Eisenhower in 1953.  In a departure from previous conflicts, inflation did not materialize after war’s end (though a recession did nonetheless).

This brings us to Vietnam.

This Time it’s Different

Well, clearly it’s different.  But in what ways is it different?

Part of the difference had to be political.  In a stark departure from the Second World War and Korea, Johnson never imposed price controls.  For the first time during the twentieth century, it was a Republican, Richard Nixon, who imposed price controls in wartime America.

So, were recessions no longer wringing inflation out with elevated unemployment?  Let’s see.  Here’s inflation:

Year Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Annual
1969 4.40 % 4.68 % 5.25 % 5.52 % 5.51 % 5.48 % 5.44 % 5.71 % 5.70 % 5.67 % 5.93 % 6.20 % 5.46 %
1970 6.18 % 6.15 % 5.82 % 6.06 % 6.04 % 6.01 % 5.98 % 5.41 % 5.66 % 5.63 % 5.60 % 5.57 % 5.84 %
1971 5.29 % 5.00 % 4.71 % 4.16 % 4.40 % 4.64 % 4.36 % 4.62 % 4.08 % 3.81 % 3.28 % 3.27 % 4.30 %
1972 3.27 % 3.51 % 3.50 % 3.49 % 3.23 % 2.71 % 2.95 % 2.94 % 3.19 % 3.42 % 3.67 % 3.41 % 3.27 %
1973 3.65 % 3.87 % 4.59 % 5.06 % 5.53 % 6.00 % 5.73 % 7.38 % 7.36 % 7.80 % 8.25 % 8.71 % 6.16 %
1974 9.39 % 10.02 % 10.39 % 10.09 % 10.71 % 10.86 % 11.51 % 10.86 % 11.95 % 12.06 % 12.20 % 12.34 % 11.03 %
1975 11.80 % 11.23 % 10.25 % 10.21 % 9.47 % 9.39 % 9.72 % 8.60 % 7.91 % 7.44 % 7.38 % 6.94 % 9.20 %
1976 6.72 % 6.29 % 6.07 % 6.05 % 6.20 % 5.97 % 5.35 % 5.71 % 5.49 % 5.46 % 4.88 % 4.86 % 5.75 %
1977 5.22 % 5.91 % 6.44 % 6.95 % 6.73 % 6.87 % 6.83 % 6.62 % 6.60 % 6.39 % 6.72 % 6.70 % 6.50 %
1978 6.84 % 6.43 % 6.55 % 6.50 % 6.97 % 7.41 % 7.70 % 7.84 % 8.31 % 8.93 % 8.89 % 9.02 % 7.62 %
1979 9.28 % 9.86 % 10.09 % 10.49 % 10.85 % 10.89 % 11.26 % 11.82 % 12.18 % 12.07 % 12.61 % 13.29 % 11.22 %
1980 13.91 % 14.18 % 14.76 % 14.73 % 14.41 % 14.38 % 13.13 % 12.87 % 12.60 % 12.77 % 12.65 % 12.52 % 13.58 %
1981 11.83 % 11.41 % 10.49 % 10.00 % 9.78 % 9.55 % 10.76 % 10.80 % 10.95 % 10.14 % 9.59 % 8.92 % 10.35 %
1982 8.39 % 7.62 % 6.78 % 6.51 % 6.68 % 7.06 % 6.44 % 5.85 % 5.04 % 5.14 % 4.59 % 3.83 % 6.16 %
1983 3.71 % 3.49 % 3.60 % 3.90 % 3.55 % 2.58 % 2.46 % 2.56 % 2.86 % 2.85 % 3.27 % 3.79 % 3.22 %
1984 4.19 % 4.60 % 4.80 % 4.56 % 4.23 % 4.22 % 4.20 % 4.29 % 4.27 % 4.26 % 4.05 % 3.95 % 4.30 %
1985 3.53 % 3.52 % 3.70 % 3.69 % 3.77 % 3.76 % 3.55 % 3.35 % 3.14 % 3.23 % 3.51 % 3.80 % 3.55 %
1986 3.89 % 3.11 % 2.26 % 1.59 % 1.49 % 1.77 % 1.58 % 1.57 % 1.75 % 1.47 % 1.28 % 1.10 % 1.91 %

And unemployment:

Year

Jan

Feb

Mar

Apr

May

Jun

Jul

Aug

Sep

Oct

Nov

Dec

 

1969

3.4 3.4 3.4 3.4 3.4 3.5 3.5 3.5 3.7 3.7 3.5 3.5  

1970

3.9 4.2 4.4 4.6 4.8 4.9 5.0 5.1 5.4 5.5 5.9 6.1  

1971

5.9 5.9 6.0 5.9 5.9 5.9 6.0 6.1 6.0 5.8 6.0 6.0  

1972

5.8 5.7 5.8 5.7 5.7 5.7 5.6 5.6 5.5 5.6 5.3 5.2  

1973

4.9 5.0 4.9 5.0 4.9 4.9 4.8 4.8 4.8 4.6 4.8 4.9  

1974

5.1 5.2 5.1 5.1 5.1 5.4 5.5 5.5 5.9 6.0 6.6 7.2  

1975

8.1 8.1 8.6 8.8 9.0 8.8 8.6 8.4 8.4 8.4 8.3 8.2  

1976

7.9 7.7 7.6 7.7 7.4 7.6 7.8 7.8 7.6 7.7 7.8 7.8  

1977

7.5 7.6 7.4 7.2 7.0 7.2 6.9 7.0 6.8 6.8 6.8 6.4  

1978

6.4 6.3 6.3 6.1 6.0 5.9 6.2 5.9 6.0 5.8 5.9 6.0  

1979

5.9 5.9 5.8 5.8 5.6 5.7 5.7 6.0 5.9 6.0 5.9 6.0  

1980

6.3 6.3 6.3 6.9 7.5 7.6 7.8 7.7 7.5 7.5 7.5 7.2  

1981

7.5 7.4 7.4 7.2 7.5 7.5 7.2 7.4 7.6 7.9 8.3 8.5  

1982

8.6 8.9 9.0 9.3 9.4 9.6 9.8 9.8 10.1 10.4 10.8 10.8  

1983

10.4 10.4 10.3 10.2 10.1 10.1 9.4 9.5 9.2 8.8 8.5 8.3  

1984

8.0 7.8 7.8 7.7 7.4 7.2 7.5 7.5 7.3 7.4 7.2 7.3  

1985

7.3 7.2 7.2 7.3 7.2 7.4 7.4 7.1 7.1 7.1 7.0 7.0  

1986

6.7 7.2 7.2 7.1 7.2 7.2 7.0 6.9 7.0 7.0 6.9 6.6  

Before I mention anything else, the effect of the March 2-19, 1973 collapse of the fixed exchange rate system is prominent in the inflation data.  The market-forced debut of the floating exchange rate system, not the end of gold convertibility on August 15 1971, killed off the last vestiges of the hapless gold standard.

In 1970, unemployment peaks at 6.1% in December and inflation falls from a high of 6.20% in December 1969 to 4.16% by April 1971 (I am ignoring the effects of Stage I & II price controls on inflation in 1971 and 1972).  Seems unemployment would cause inflation to drop even before Nixon resorted to the “freeze.”

In 1975, unemployment hits 9.0% in May and inflation falls from a high of 12.34% in December 1974 to 4.86% in December 1976.  Pretty dramatic, wasn’t it?  Onto Paul Volcker…

In 1980, unemployment peaks at 7.8% in July and inflation falls from a high of 14.76% in April to 9.55% in June 1981; in 1982, unemployment peaks at 10.8% in November and December of that year and inflation falls from a high of 10.95% in September 1981 to 1.10% in December 1986.

Here is the dramatic turn.  Disinflation wasn’t introduced into this country from 1980 to 1982 as Matthew Yglesias suggests.  Disinflation was introduced into this country in 1980 on a permanent basis.

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5 thoughts on “Revisiting the Wage-Price Spiral (Part of the Turn to Disinflation Series)

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