Echoes of Swinging Sixties Fan Fears of Resurgent U.S. Inflation
(Bloomberg) -- U.S. unemployment looks to be headed down to levels last seen when The Monkees ruled the pop charts and Ford Mustangs roamed the roads. And that’s got some economists and investors worried.
Yes, it was the Swinging ’60s -- 1966 to be precise. Joblessness, which now stands at 4.1 percent, fell as low as 3.6 percent. That’s the same rate that Federal Reserve policy makers see the U.S. hitting at the end of next year. And inflation, after being quiescent for years, took off back then, virtually doubling over the year to 3 percent.
“There’s a risk that something like that could happen again,” said Joachim Fels, global economic adviser at Pacific Investment Management Co., which oversees $1.75 trillion in assets.
That could shock financial markets that have become accustomed to muted price pressures and easy monetary policy.
The government’s monthly jobs report on Friday is projected to show the unemployment rate ticked down to 4 percent in March as employers added another 195,000 workers, according to the median forecasts of economists surveyed by Bloomberg ahead of the release.
It’s not only the labor market that exhibits some parallels to the mid-1960s. Just as now, fiscal policy was pumped up, by tax cuts first pushed by President John F. Kennedy and by the guns-and-butter spending splurge of his successor, Lyndon Baines Johnson.
Monetary policy was accommodative -- and Fed officials were under political pressure to keep it that way, just as may be starting to happen now. After being named head of President Donald Trump’s National Economic Council, Larry Kudlow urged the central bank on March 14 to “just let it rip, for heaven’s sake.”
“This reminds me of the late 1960s when we experimented with low rates and fiscal stimulus to keep the economy at full employment and fund the Vietnam War,” Paul Tudor Jones, founder of hedge fund Tudor Investment Corp., said in comments to Goldman Sachs Group Inc. published Feb. 28. “We are setting the stage for accelerating inflation, just as we did in the late ’60s.”
To be sure, repeated forecasts by inflation-phobes that prices were about to take off have been wide of the mark. As measured by the Commerce Department’s personal consumption expenditures price index, inflation stood at 1.8 percent in February and has been more or less consistently below the Fed’s 2 percent goal since the target was introduced six years ago.
Former Fed governor Frederic Mishkin argued that a big difference from the 1960s is that inflation expectations now are well-anchored. What’s more, the Fed recognizes how important it is that they remain so.
As a result, the likelihood of getting a “very sharp acceleration of inflation is much, much, much less” than back then, Mishkin, who is now a professor at Columbia University, said March 21 on Bloomberg Television.
Best that can be judged, inflation expectations were anchored back in the early 1960s as well, said Matthew Luzzetti, senior economist with Deutsche Bank in New York. But that didn’t prevent inflation from increasing, pushing up expectations in the process.
The 1966 price spurt was just the beginning, of course. By the end of the decade, inflation reached almost 5 percent and, in spite of a mild recession at that time, went on to double-digit levels in the 1970s -- something that nobody is forecasting will happen again today.
Labor unions were stronger and wage growth was faster in the mid-1960s than they are now. But unit labor costs -- a key ingredient in the inflation process -- were actually rising more slowly heading into 1966, thanks to bigger productivity improvements.
What Our Economists Say
Labor costs are typically the single largest input cost in nearly every industry, so if policy makers drive labor scarcity far enough, they will ultimately push the inflation trend higher. However, Bloomberg Economics expects the re-emergence of inflation pressures in 2018 to prove surprisingly sluggish. This is in large part due to the fact that there is more slack in the labor market than the unemployment rate alone suggests -- any rebound in wage pressures will be at least partially muted by rising labor-force participation.
-- Carl Riccadonna and Yelena Shulyatyeva, Bloomberg Economics
The future course of inflation may ultimately boil down to whether there’s a kink in the Phillips Curve. The experience of the last 20 years indicates that the curve is very flat -- that is, continued declines in the jobless rate don’t lead to much, if any, increase in inflation.
But the build-up in price pressures in the mid-1960s suggests that inflation can pick up more quickly once the jobless rate breaches a certain level.
A paper last year by former Fed staffers Nathan Babb and Alan Detmeister looking at U.S. metropolitan data found that indeed was the case and concluded that such effects become significant below a 3.75 percent unemployment rate.
“It takes time once you hit that 3.75 percent level for the inflation rate to really start to rise,” said Detmeister, now an economist with UBS Securities LLC in New York. “The further you move below 3.75 percent, the more quickly that build-up becomes.”
UBS is forecasting inflation of roughly 2 percent this year and next, but Detmeister said price pressures could pick up more strongly after that if joblessness falls to the 3.3 percent level that the bank expects by the end of 2019.
Deutsche Bank’s Luzzetti sees a risk that inflation -- even excluding volatile food and energy costs -- could hit 2.5 percent or more in the coming years.
“You have to qualify historical analogies because nothing is ever the same,” said Rutgers University monetary historian Michael Bordo, who is writing a paper on the U.S. economy in the 1960s. “But this is a pretty good one.”
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