Economic history may not repeat itself, but it certainly echoes sometimes. We have noted some of the recent echoes of the 1970s, but there are some important differences that have convinced us that we’re not about to repeat that decade’s prolonged and painful experience with stagnant growth and high inflation.
There are also other echoes we’re hearing, and fortunately they sound less ominous. Having just celebrated Queen Elizabeth II’s Platinum Jubilee, let’s wind the economic clock back to 1952, the year she ascended to the throne… far from home, a war is decimating an eastern country, causing a synchronised spike in the cost of commodities. Here in the UK, inflation is running alarmingly high… So far, this uncanny parallel between the Queen’s Jubilee and her Accession — of the invasion of Ukraine and the Korean War — is not what you would call a pleasant echo. But it’s made more palatable by the fact that inflation rapidly returned to normal in 1953. Does this offer hope for 2023?
High inflation and labour shortages
When Elizabeth II was crowned, interest rates were low by historic standards at 2% (though they are a little over half that today). Inflation was climbing toward a peak of 9.2%, eerily close to the 9.1% inflation in the latest release of CPI data. Like today, there was also low unemployment and a labour shortage. In that post–war year, national debt was high too, eventually peaking at 250% of GDP, compared with about 100% now after a massive surge in spending on the battle against Covid-19.
A crucial difference between 1952 and the high inflation of the disco era — one that makes 1952 more akin to 2022 — is that wages and prices weren’t spiralling as they did in the 1970s, and inflation did not become entrenched. In the period of high inflation in the early 1950s, UK interest rates peaked at 4%. Current consensus forecasts are for the Bank of England’s base rate to peak at 3.25% next year (although we are sceptical it will rise that far). By June 1954, inflation had retreated back down to 0.7%. Government policies after the end of the Second World War encouraged mass migration from Commonwealth nations, which helped alleviate the labour shortage and had a dampening effect on wage pressures.
Such policy is unlikely to be repeated today. Yet while labour shortages in some pockets of the economy are leading to sharp increases in wages, average UK wage growth remains well below inflation. In the late 1960s and early 1970s, wage inflation ran ahead of price inflation. We don’t expect it to start doing so now, not least because labour market institutions are different — there are few inflation–indexed wage contracts, labour movements are weaker and so is bargaining power (union settlements are still, by and large, well short of inflation).
A series of unique shocks
Just like in the early 1950s, today’s inflation is primarily explained by a series of unique shocks to the supply of goods and services over the last two years, rather than fundamental shifts in the inflation forming process. In the UK, 75% of today’s inflation is due to food, energy and the categories of goods that had outsized demand during lockdown and supply chains that failed to keep up — in the eurozone it is over 80% and in the US it’s about two–thirds.
In other words, we think we would need more shocks to cause a more profound, longer–lasting shift in the rate of inflation. The economic outlook may not be as bright today as it would’ve been as Queen Elizabeth II headed into the second year of her reign, but we have solid grounds for hope that inflation — that arch nemesis — will also be in retreat as we head into Her Majesty’s eighth decade