The End Of the Age Of Inflation

Washington Post 12/02/04
author: Robert J. Samuelson
Copyright 2004, The Washington Post Co. All Rights Reserved

The Age of Inflation is finished. Over the past four decades, the rise and fall of double-digit inflation has been the most significant force affecting the U.S. economy. Inflation rose from a little less than 2 percent in 1960 to 13 percent in 1979 and then gradually descended to a little less than 2 percent in 2003. Going up, inflation generally harmed the economy -- causing harsh recessions, a stagnant stock market and lackluster gains in living standards. Coming down, inflation generally helped the economy -- leading to longer expansions, a stock market boom and stronger gains in living standards.

That's the Age of Inflation in a nutshell, but it's barely understood.

One reason is simply the passage of time. Americans who were 20 in 1980, when double-digit inflation was at its most destructive, were barely old enough to appreciate what was happening. Yet, those people (now 44) are older than two-thirds of the population. They have no memory of rising inflation. As for declining inflation, its benefits have occurred in a gradual and almost invisible manner. We haven't paid much attention. Our economic debates blame or credit high-profile presidential policies (Reagan's tax cuts, Clinton's budget surpluses or Bush's deficits) or focus on more dramatic upheavals: the Internet or globalization.

Inflation mattered more than any of these.
...
The gains from purging double-digit inflation are a great untold story. The Federal Reserve's staunch anti-inflationary policies, and stiff competitive pressures (from imports to the rise of Wal-Mart), demolished the deadly wage-price spiral. We've been reaping the benefits ever since. These gains -- not Reagan's tax cuts or Clinton's budget policies -- mostly explain the economy's fabulous performance in the 1990s.

Some benefits (perhaps higher productivity growth and a smoother business cycle) may endure. But others, unfortunately, are fleeting. You can't repeat the benefits of the steep fall of interest rates from double-digit inflationary levels. The same is true of the extraordinary rebound of the stock market. It was a one-time recovery from inflation's damage. Future changes in inflation, interest rates and stocks will be smaller. Indeed, some economists now expect slight increases in inflation and interest rates. Deutsche Bank predicts that rates on 10-year Treasury bonds will rise to 5.5 percent by the end of 2005, the highest since late 2000.

The economy must now move ahead without the powerful afterburners of soaring stocks or rapidly falling interest rates. These were the final chapters of the Age of Inflation. It's over. What comes next is anyone's guess.