How An Old Banking Regulation May Have Driven The 1970s Inflation

Joe Weisenthal (0:10)

Hello, and welcome to another episode of the Odd Lots Podcast. I'm Joe Weisenthal.

Tracy Alloway (0:15)

And I'm Tracy Alloway.

Joe Weisenthal (0:17)

Tracy, obviously, we're recording this September, 2023 Inflation has come way down over the last year, but there is definitely anxiety about, well, could we see another wave, particularly if we don't have a recession?

No one is really convinced that it's over.

Tracy Alloway (0:34)

Right, so gas prices are starting to creep up again.

House prices have been incredibly stable and also starting to rise slightly. So that could also figure into shelter costs. But I think generally there is this concern that are we going to see another leg up in inflation? And part of the reason there seems to be this concern is because as we've discussed on this podcast before, everyone tends to reach for the 1970s as the big parallel or analogy for periods of higher inflation.

Joe Weisenthal (1:06)

Right, when we were out in Jackson Hole, I guess in August, that was when Larry Summers tweeted that famous chart saying it's a good reminder, right?

Tracy Alloway (1:15)

This was when you were looking at the mountains and thinking of US CPI charts.

Joe Weisenthal (1:19)

Yeah, the Grand Tetons looked like the US CPI from 1974 to 1985 But it's true that throughout the 70s, there were multiple times where people sort of breathed a sigh of relief. They said inflation has been licked, and then it came back. And it's really, there's this story that there was all this irresponsible policy, and then finally Volcker came and smashed inflation. And it really did not exactly happen like that.

Tracy Alloway (1:44)

Right, I always find that kind of weird because Arthur Burns hiked rates a lot before Volcker did the same thing. But you're absolutely right. And the inflation of the 1970s, it's important in many ways, possibly not the right ones, but one of the ways it's important is it tends to be the period that a lot of our policy makers and economists and academics kind of came of age in. And it tends to be the one that they go back to to explain what's happening now. And so, there are some shades of the 1970s to our current situation. You did have supply shocks in the form of oil. There was, I think, some fiscal stimulus from the Vietnam War going into the 1970s, things like that.

But overall, the sort of standard interpretation of the 1970s is that monetarist view, the old Milton Friedman, inflation is always and everywhere a monetary phenomenon, and basically blaming the Fed for not reacting fast enough.

Joe Weisenthal (2:45)

You're absolutely right. And you mentioned that the 1970s looms so large, policymakers, the Fed in particular, central bankers, they take a lot of pride in the fact that they defeated inflation, that inflation has been stable, that they sort of embedded this idea of stable inflation expectations. They prize that stability quite a bit. You and I, we joke a lot about how we both started our careers in 2008, right on the eve of the crisis.

Tracy Alloway (3:12)

Right, so we're always worried about deflation.

Joe Weisenthal (3:14)

We're always worried about crisis and downturn and surging unemployment. So it had, and you look at the people who now make policy today, many of them, as you said, came of age then. But again, it feels as though, if we're gonna have a conversation about possible second waves, if we're gonna compare and contrast now with the 1970s, then actually we better get a better handle on what really happened in the 1970s. Because I don't think that outside of these vague things, like, oh, they let policy run too loose and some oil and gas lines, that actually we've really, that there is a crisp, coherent story like, yeah, but why was inflation so persistent and so reoccurring throughout roughly a decade?

Tracy Alloway (3:56)

The ghost of Paul Volcker is gonna be so mad at us, but I think we should do this.

Joe Weisenthal (4:00)

Well, I am very excited.

We have the perfect guest, someone who has done original research on 1970s inflation and really sort of broke down what happened. We are gonna be speaking with Itamar Drechsler. He is a professor of finance at the University of Pennsylvania. Someone who's done a lot of research on this period and what it means. Professor Drechsler, thank you so much for coming on Odd Lots.

Itamar Drechsler (4:22)

Thank you very much for having me. This is really fun and nice to talk about a topic I care a lot about and think is very interesting.