What does the chart show?
 

This chart shows a comparison between the trends in year-on-year Consumer Price Index (CPI) from 1966-1980 and 2013-2023, highlighting the striking similarity in the two periods. Not only are the trends eerily reminiscent of the 1970s, but many of the challenges central banks have been faced with are also alike. The pandemic and Russia’s invasion of Ukraine bear resemblances to the Yom Kippur War in 1973, as in both instances exogenous shocks caused widespread supply constraints and subsequent inflationary pressures. The chart also illustrates how after an initial decrease in inflation after 1975, there was a significant rebound in prices, predominately driven by a surge in the oil price. Given the recent uptick in inflation following a rise in oil prices, this is a situation that the Federal Reserve (Fed) hopes to avert this time around. The first worrying signs that the trend is being followed were seen in the slight uptick in inflation earlier this month, a reversal also driven by oil price rises.

Why is this important?

Federal Reserve Chair, Jay Powell, has already faced the consequences of not learning from previous mistakes, after judging the early inflationary pressures as ‘transitory’ and merely a product of exogenous shocks. Former chair, Arthur Burns (1970-78) made the same error, pointing to cost-push shocks as the culprit for high inflation, highlighting how in both cases, the damaging lagged effects of ultra-loose monetary policy were ignored. The consequence of the substantial rebound of inflation in the late ‘70s, was a painful correction period which necessitated unprecedented rises in interest rates implemented by the infamous Paul Volcker, resulting in severe back-to-back recessions. There has however, been an important paradigm shift in the monetary framework used today compared to the 1970s. Previously, monetary supply was used as the main instrument of policy alongside non-monetary actions such as taxation and implementing wage or price controls, while the Federal Funds Rate was considered ineffective and unnecessary. This has meant that today, the Fed is much better positioned to handle inflationary pressures and prevent the entrenchment of high prices in expectations. Even so, the chart still serves as a warning of the potential consequences of declaring victory over inflation too early, and the growing narrative of rates staying higher for longer is a promising sign that the Fed has learnt this lesson. The Fed will certainly be hoping that 2024 will be the year that this visually appealing correlation breaks down.