How Inflation Became a Fact of Life

We think of the 1970s as the era of shock inflation. But it was in the 1950s that the world discovered "The New Inflation" — the beginning of the era of permanently rising prices.

Inflation might seem to be one of those afflictions, like death or taxes, that has always been with us, but until the middle of the twentieth century, the kind of inflation we’ve experienced all our lives — a steady, long-term upward slope in the price level — had never been seen.

Before World War II, the tendency of prices was to rise during economic booms but then fall in the subsequent busts. They would rise especially fast during wars, but then fall almost as quickly during postwar readjustments. The net result, in the main capitalist economies, was an inflation rate that fluctuated erratically from year to year, but that averaged out, in the long run, at around zero.

The contrast with our own era makes for some striking numbers. In the last, say, six months, there’s been more inflation in the UK than occurred, on net, over the whole sixty-three year reign of Queen Victoria. (When she died in 1901, the level of British consumer prices was 7% lower than when she acceded to the throne in 1837.)

Or consider the era we now call the Great Moderation (1985–2007). Though it owes its name to the fact of its “low” inflation rates, it nevertheless saw more inflation over its 22 years (an 87% increase in the price level) than occurred over the 150 years preceding World War I (a 76% increase).

A notable by-product of that older, zero-inflation regime was that it imbued the public with a sense of what Milton Friedman, in his 1976 Nobel Prize address, called a “normal price level.” In the eighteenth and nineteenth centuries, this feeling was, in Friedman’s words, “deeply imbedded in the financial and other institutions of [the US and UK] and in the habits and attitudes of their citizens.”

A case in point: shortly after the armistice ending World War I, the renowned economist Irving Fisher warned that a sharp economic slowdown was underway in the United States because, he wrote, with the price level having risen 60% over the four years of war, “most people expect prices to drop”:

People quote the disparity between present prices and those prevailing “before the war,” and decide they will not buy much until present prices get down to “normal.” This general conviction that prices are sure to drop is putting a brake upon the entire machinery of production and distribution.

Today this whole concept of a normal price level belongs to a vanished mental universe. It’s been replaced in the public’s mind by a sense of what a normal inflation rate looks like — a 2%- or 3%-per-year increase in the price level; not too much higher; certainly not less than zero. After a burst of inflation, the expectation is no longer that prices will return to their old levels, but that the rate of change of prices will return to its old level.

The shift from the old inflation regime to the new didn’t take place gradually. The old regime collapsed, as old regimes tend to do, with surprising suddenness: essentially over the course of the second quarter of the twentieth century.

A simple way of gauging the change is to compare the number of inflationary versus deflationary years within a given period. According to the Bank of England, which has compiled annual inflation estimates going all the way back to the year 1207, over the seven centuries prior to World War I, that balance was almost even: there were 295 years of inflation and 258 of deflation, with the remaining 147 years seeing zero change in the price level.

It was even more balanced if we exclude the sixteenth century, when Spain was flooding Europe with New World precious metals, and the years of the “French Wars” (1793–1815) when Britain was off the gold standard; by that reckoning, there were 230 years of inflation and 218 years of deflation (plus 129 years of zero change in prices). And the pattern was consistent: even the century just preceding World War I saw 50 years of inflation versus 48 years of deflation.

Then, in 1931, faced with the sharpest economic contraction in its history, Britain permanently abandoned the gold standard. Two years later, with the worst of the Slump receding and recovery incipient, the country had its last deflationary year. Since 1934 Britain’s annual inflation rate has been positive not half, or even two-thirds of the time, but 89 times out of 89. Similar figures could be adduced for most of the countries in the industrialized world.

But this shift, while easy to spot in retrospect, took decades for contemporaries to perceive in real time. Because centuries of experience had taught that inflation was mainly a wartime exception to a long-run rule of stable prices, a general recognition that something had permanently changed in the behavior of prices would have to await the return of a semblance of peacetime economic conditions. But with the late 1930s seeing a wave of rearmament, followed by a world war, followed by the economic chaos of postwar adjustment and Cold War remobilization, it was not until the Korean War armistice in 1953 that earnest expectations of a return to economic “normality” really took hold.

And it did seem, at first, as if the old nineteenth-century pattern was reasserting itself: in the United States, 1954 and 1955 saw inflation rates, as measured by the consumer price index, that were close to zero.

[Read the rest at Jacobin.]