Opinion – Martin Wolf: Policy Mistakes of the 1970s Echo in Our Time

Unexpectedly high inflation, wars in key commodity-producing regions, falling real wages, slowing economic growth, fears of monetary policy tightening and stock market turmoil – we see all these things in the world economy today. They were also the dominant features of the world economy in the 1970s.

This period ended in the early 1980s, with a brutal monetary tightening in the US, a sharp reduction in inflation and a wave of debt crises in developing countries, especially in Latin America. It was also followed by major changes in economic policy: conventional Keynesian economics was buried, labor markets were liberalized, state-owned enterprises were privatized, and economies opened up to trade.

How close are the parallels, especially with the 1970s? What are the differences? And what can we learn from these mistakes? The World Bank’s Global Economic Outlook, released last week, addresses these questions. The parallels are clear, as are the differences. Not least, there are mistakes to avoid: don’t be too optimistic; don’t take high inflation lightly; and don’t leave vulnerable people and economies unprotected from their own shocks and their painful legacies.

What are we seeing already equating to stagflation – defined as a prolonged period of higher-than-expected inflation and lower-than-expected growth? The answer is “not yet”, but it is a risk.

Inflation is well above target in almost all countries. As in the 1970s, this is partly due to one-off shocks – at the time, two wars in the Middle East (the Yom Kippur war in 1973 and the Iran-Iraq war, which started in 1980), this time it’s Covid and the Russia’s invasion of Ukraine. The most important is the danger that this inflation will be incorporated into expectations and, therefore, into economies.

Part of the reason this risk intensified in the 1970s was the failure to recognize in time the slowdown in the potential growth rate. Today, too, optimists assume that pre-pandemic growth trends will continue. However, the World Bank argues, “Over the 2020s as a whole, potential global growth is expected to decelerate 0.6 percentage point below the 2010 average.”

The echoes of the 1970s are loud, then: higher-than-expected inflation, major shocks, and weakened growth. But the differences are also encouraging. The real price of oil jumped substantially more between 1973 and 1981 than this time. Global inflation is also much less widespread than it became in the 1970s. This is especially true of “core” inflation. However, perhaps it is because we are at an early stage of the inflationary process. Inflation tends to become broader the more persistent it is.

Monetary policy frameworks are also more credible and more focused on price stability than they were in the 1970s. But this last point has also become less true recently, especially in the US. Furthermore, expectations of inflation in, say, 1970 were certainly not for inflation that occurred later. Policymakers tended to blame inflation on temporary factors as well, as we have seen more recently.

Economies are more flexible today than they were in the 1970s, it’s true. But the rise of protectionism could lead to a reversal of this aspect. Energy intensity has certainly dropped since then. But energy prices are still important. Finally, fiscal policy is expected to be less expansionary this time around, although it was a lot in 2020 and 2021.

All in all, the assumption that things will be very different this time around is plausible, but far from certain.

Above all, whether it is true depends on what policymakers do. They need to avoid the mistake of allowing inflation to spiral out of control, as it did in the 1970s. They should still have time to do that. But acting decisively also poses dangers, most obviously from an unnecessarily sharp downturn, with the economic costs that would follow. Against this, it is possible that changing demographics, slower technological change, deglobalization, the depletion of important earlier growth opportunities, and rising populism will weaken disinflationary forces in the long run. This would make it even more difficult to achieve and sustain low inflation.

An obvious danger arises in the only way the world economy appears more fragile than it did 40 years ago: the size of the debt stock, especially the stock denominated in foreign currency. Crucially, this is not just true for emerging and developing countries. The euro is also, in essence, a foreign currency for a crisis-stricken member of the eurozone.

If monetary policy tightening is substantial and prolonged, messy and costly debt crises are likely to emerge. Lenders are widely believed to be in a better position to weather these blows than international banks were in the early 1980s. But borrowers may not be: it must be assumed that those who can choose between importing food and energy , on the one hand, and debt service, on the other, will typically choose the former.

It is also too optimistic even to be sure that the shocks to the real economy are over. The virus may have more ghastly tricks up its sleeve. Also, no one knows how the war will unfold. In addition, some of the measures being discussed, notably the ban on maritime insurance on Russian oil shipments, could lead to further jumps in global oil prices. Russia could also cut gas exports to Europe, creating more unrest.

I worked as an economist at the World Bank in the 1970s. What I remember most about that period is the widespread uncertainty: we had no idea what would happen next. Many mistakes were made, some out of over-optimism and others out of panic. The past does not repeat itself. But it’s rhyming. Don’t ignore the poetry of time.

Translated by Luiz Roberto M. Gonçalves