Rich Western industrialised countries appear to be caught in a time loop, with unexpectedly higher inflation bringing back not just memories of the 1970s but also that era’s policy debates and the political insecurities. The debates of the 1970s were not just about technical matters of macroeconomic management. They also raised doubts about the sustainability and legitimacy of the Western model of democracy. The world was beset by geopolitical instability, and the United Nations General Assembly endorsed calls for a New International Economic Order.
And now that many of the same old political and geopolitical issues are heating up again, inflation is a thermometer. As more money chases fewer goods, prices rise – the economy becomes feverish.
During periods of monetary innovation, however, it becomes harder to tell what money even is. No-one would dispute the fact that monetary innovation has been proceeding at a breakneck pace over the past decade. But it is worth remembering that the 1970s also featured a financial revolution, one that blurred previously hard distinctions between money and non-money.
This was partly a consequence of inflation, which prompted bank customers to flee from non-interest-bearing checking accounts to alternatives such as certificates of deposit or accounts in non-traditional banks. Friedman was contemptuous of all the conservative voters and politicians who thought that fiscal policy was to blame for inflation. But his disdain was misplaced, because there was indeed a connection between fiscal and monetary policy: high government deficits had been financed through the central bank. In both the United States and the United Kingdom, the treasury and the central bank had come to be seen as a unified “macroeconomic executive.” Regarding themselves as globally dominant powers, both countries aimed to use their monetary sovereignty to secure advantages at the expense of the rest of the world.
In the event, the US and UK ended up with higher inflation compared to most other industrialised countries, and this same distinction is apparent again in 2022. The US and the UK have the highest inflation rates in the G7, and they also both enacted massive central-bank-assisted fiscal-stimulus packages in response to the Covid-19 shock. The UK is a particularly dramatic example of this. In the first financial year of Covid-19, the Bank of England (BoE) bought up 99.5% of government debt – and over 100% the following year. Under these circumstances, it is not credible to argue that the central bank is independent.
The upshot is that central banks are not as independent as they purport to be. In both the UK and the US, governments and central banks have been responding to the political pressures created by apparently intractable societal divisions. Such extreme polarisation raises questions about whether the political union can continue. Hence, the 1970s-era debate about the UK’s ungovernability is reappearing, with both Scotland and Northern Ireland eyeing paths out so that they can rejoin the European Union. Even more ominously, a slew of recent books prophesy a civil war in the US. Of course, Europe, too, faces threats of disintegration. The European Central Bank (ECB) has been even slower than the Fed or the BoE to raise interest rates. This is partly because the character of the inflation is different, and because Russia’s war in Ukraine has driven up energy costs. European labour markets also have somewhat more slack (though some European economies are suffering the same dramatic shortages of skilled labour seen in the US and the UK).