Why this inflation is different

Commentators and politicians are frightening Americans about inflation without understanding and explaining why it burst on the scene last summer as COVID-19 receded. A growing consensus among inflation hawks says that the surge in prices is the result of the Federal Reserve’s failure to raise interest rates and slow the economy soon enough. Worse, the hawks tell Americans that the Fed must squeeze harder and that its “mistake” could lead to a long period of “stagflation” like the one the U.S. endured from 1974 to 1981. It is important to respond to this foolishness.  

Today’s inflation palaver fails utterly to explain the two most important facts about the recent burst of rising prices. The first is that energy prices are inflation’s principal drivers here and in the rest of the world, and the U.S. does not control these prices. Even in Germany where fighting inflation is a civic religion, prices are rising at roughly the rate in the U.S. A second even more important fact is that there is a huge difference between the tech-driven U.S. economy in 2022 and the inflation-prone one of the 1970s. The ’70s economy was built around post-World War II industries dominated by monopolies and oligopolies that often could raise prices without regard to supply and demand. The U.S. economy today is led by tech companies that whatever their faults battle each other for markets and usually grow by innovating and cutting prices.  

To begin, it should be clear that energy prices tell the story of inflation in 2022 as they did in the 1970s. Gasoline has more than doubled from $1.94 gallon in April 2020 when COVID-19 was curtailing driving, to $4.60 the other day. Sharply rising gasoline prices mean that the OPEC oil cartel is in the driver’s seat again, pushing oil from $41.47 a barrel in 2020 to roughly $113 in May 2022. This is a painful reminder of what happened a half-century ago when the OPEC cartel cut oil supplies and drove prices from $1.82 a barrel in 1972 to $35.50 in 1980, 19 times higher. (There are 42 gallons in a barrel.) 

Rising oil prices raise the cost of gasoline of course, but also of diesel, heating oil, propane, and hydrocarbon “feedstocks” made from natural gas, oil and coal that often are substitutes for oil. Higher prices for oil and oil-substitutes, in turn, cause inflationary price increases in a whole range of products and services. They pull up the costs of electricity, home and office heating and cooling, manufacturing, plastics, textiles, transportation of all types, farm prices (fertilizer, tractor fuel, costs to ship to markets), restaurant meals, and much more. 

The U.S. economy, though, has changed since the 1970s, which will make inflation less painful to manage if we don’t let the inflation hawks panic us. The U.S. economy of the 1950s, ’60s and ’70s was dominated by post-Depression post-World War II industries that were sheltered by government-sanctioned price-fixing arrangements that raised prices year after year. The U.S. economy in 2022 is different. The OPEC cartel’s ability to cut supply and raise prices is still there but the price fixing arrangements in communications, transportation, manufacturing, finance, retailing and many other areas are gone, so that prices now fall as well as rise.  

In the 1950s, ’60s, and ’70s, prices in large sectors of the economy were “administered” by business and labor monopolies and oligopolies so that prices rose year after year, but rarely came down. The best-known economist of the period, John Kenneth Galbraith, a wonderful writer and friend of President John F. Kennedy wrote about this in his 1967 book, “The New Industrial State.” Galbraith said that the economy was divided into two broad categories: those where prices and wages were “administered” and those where competition kept inflation down. He was certainly right about this, but he was wrong to believe that the political power of the entrenched industries and unions would prevent that situation from changing. 

The economy did change radically between 1973 and 1983-84. The administrations of Presidents Gerald Ford and Jimmy Carter, with bipartisan help from Congress took action to break up the inflationary price fixing arrangements that were the heart of the post-World War II economy. The specifics need to be recognized as Americans think about inflation today.  

In the 1970s, Presidents Ford and Carter backed up the courts and the Federal Communications Commission (FCC) that broke up AT&T’s (aka Ma Bell’s) telephone monopoly. Communications costs in the 1980s plunged – in some cases by 95 percent – and today businesses and individuals have low-cost choices that were unimaginable in the 1970s. Ford and Carter also supported the Securities and Exchange Commission (SEC) and various federal banking regulators who opened up stock markets and banking to more competition, lowering the costs of financing. By the same token and with the guidance of Ford and Carter appointees, the ancient Interstate Commerce Commission (ICC) opened up trucking, railroads, and pipelines to price competition that broke the power of incumbent interests to set prices. The Civil Aeronautics Board (CAB) with support from Ford and Carter also ended cozy airline price fixing and policies that locked out new air carriers since 1938. These reforms were carried out despite fierce opposition from the established companies and unions in every one of these areas.  

Manufacturing changed too. A 3-2 decision led by Carter-appointees at the International Trade Commission (ITC) had the effect of more fully opening the U.S. car market to imports from Europe and Japan and to firms from Japan, Germany and Korea that now make cars in the U.S. This undermined the pricing power of the Big 3 U.S. auto companies that had dominated U.S. manufacturing since the 1920s. In 2022 there is significant price competition, not only in new cars, but in most of the machine building, metal shaping and bending industries that cater to carmakers. (The computer chip shortage is cutting supply and raising car and appliance prices now, but this will pass as new chip making capacity comes online.) 

Natural gas was the toughest nut to crack politically. Carter fought for two years to open up both natural gas and electricity to price competition and was partly successful. As a result, natural gas prices were astonishingly low for decades, reducing the country’s dependence on coal and oil. 

All of these structural changes in the economy led to low inflation for 40 years and make today’s inflation caused by oil, transportation, and a few bottlenecks less likely to become entrenched. None of these structural changes had anything to do with Federal Reserve monetary policy that caused a recession in the early ’80s and always gets the credit for beating back that inflation. What the country needs now to fight inflation instead of another Fed-engineered recession is policies to speedily develop new sources of energy (more wind and solar would be good), further modernize transportation infrastructure, reduce the price-fixing supplier arrangements that make American health care so costly, and increase the production of things like computer chips. Slowing the economy by raising interest rates and causing a recession impedes investment in these areas and will cause far more pain for working Americans than today’s inflation. 

Paul A. London, Ph.D., was a senior policy adviser and deputy undersecretary of Commerce for Economics and Statistics in the 1990s, a deputy assistant administrator at the Federal Energy Administration and Energy Department, and a visiting fellow at the American Enterprise Institute. A legislative assistant to Sen. Walter Mondale (D-Minn.) in the 1970s, he was a foreign service officer in Paris and Vietnam and is the author of two books, including “The Competition Solution: The Bipartisan Secret Behind American Prosperity” (2005).