To judge inflation, think of pandemic as a war

The jump in US consumer prices as the economy began reopening this spring — they rose 4.2% over the 12 months ending in April — has prompted a lot of historical comparisons to the bad old inflationary days of the 1970s.
If we’re going to do historical comparisons, though, why stop at the 1970s? The Bureau of Labor Statistics has monthly consumer price index numbers going back to January 1913, allowing us to calculate 12-month inflation rates from January 1914 onward. That’s just in time to catch the biggest inflation wave in the series, with consumer prices more than doubling from 1915 to 1920 and the 12-month price increase peaking at 23.7% in June 1920.
One can find even bigger annual increases in the consumer-price estimates going back to 1774 that have been assembled by economic historians Laurence H Officer and Samuel H Williamson at MeasuringWorth. Annual inflation was 29.8% in 1778, during the Revolution, and 24.8% in 1863 and 25.1% in 1864, during the Civil War.
Major wars tend to be inflationary, as military spending creates a big new source of demand and governments print money to finance it. There were also price spikes in the aftermath of World Wars I and II as the economy shifted back from war footing to peacetime pursuits.
In the US, these wartime-and-after inflations have all been short-lived. In the 18th and 19th centuries the deflations and depressions that followed even wiped out all the wartime price gains, with consumer prices in the US about the same in 1900 as they were in 1776. That changed with the arrival of the Federal Reserve in 1914, and prices never returned to the pre-war levels of 1914 and 1941. But the high
inflation rates didn’t last long either.
That wasn’t true of the double-digit inflation of the 1970s and early 1980s, which also followed an expensive conflict (the Vietnam War) but is usually attributed to a pair of oil crises and a succession of monetary policy errors. “America’s Only Peacetime Inflation,” as it has been dubbed, lasted more than a decade and gave way to a long stretch of lower-but-sustained inflation that only really ended with the financial crisis of 2008.
The long inflation of the 1970s and after lives on in the memories of many people still active in public life and financial markets, some of whom freak out on occasion that it’s about to come roaring back. Just because the last such freak-out, around 2010, turned out to be much ado about nothing doesn’t necessarily mean all such worries are wrong now. I do think the discourse might be improved, though, by more awareness of the country’s earlier inflationary episodes, especially the two others since the Federal Reserve was created.
Yes, those were both wartime inflations, but the battle against Covid-19 has been likened to a war and led to war-sized budget deficits. The 1915-1920 inflationary period even featured a global pandemic. So here’s a brief refresher (with apologies to those reading on their mobile phones, for whom the annotations on the following charts may be a bit much).
Prices began rising in late 1915 before the US entered World War I, as European countries bought agricultural commodities and war supplies here and shipped gold to New York to pay for it. The US was on the gold standard then, so more gold in New York meant a growing money supply. US entry into the war in 1917 then brought a form of money creation more familiar to modern readers, with the Federal Reserve lending to banks at below-market rates so they could buy the government’s Liberty bonds. Buying the bonds directly — what is now called quantitative easing — was seen as a step too far. In the UK the Bank of England did it, but hid the fact for decades.
At war’s end in 1918 the leading figure in the early Fed, New York Federal Reserve Bank President Benjamin Strong, wanted to end this subsidy. But Treasury Secretary Carter Glass had one last round of Liberty bonds to sell in April and May 1919, and was concerned even after that about keeping bond prices from dropping. The fledgling Fed wasn’t going to risk bucking the Treasury Secretary, and what ensued was, in the words of the Fed’s subsequent annual report, “a year marked by industrial unrest, by economic confusion,
by reduced production,
increased domestic consumption, high prices, and extravagance.”
It’s not clear to me how much of this was due to monetary policy and how much to other factors such as the end of wartime price controls and the shift from military to consumer spending — not to mention the deadliest pandemic in world history, which was at its worst in the US in autumn 1918. In their classic “A
Monetary History of the United States, 1867-1960,” which has informed all subsequent discussion of the episode (including this one), Milton Friedman and Anna Schwartz gave all the attention to the Fed. But contemporary accounts also emphasized short-sighted
cutbacks in industrial production right after the war, increased demand from overseas, profiteering, speculation and a spirit of excess that resulted in, as the New York Times disapprovingly reported in August 1919, Louisiana lumberjacks “buying $3,000 autos, silk shirts for $10 and $12, and neckties for $5.”
More recently, some economists have concluded that the pandemic was inflationary, in part for the awful reason that it removed so many people in their 20s and 30s from the workforce and thus boosted wages for the survivors.
By the time Glass finally lifted his objection to Fed interest-rate increases at the end of 1919, Strong had concluded that the time for them had passed. But after he took a leave of absence to rest and combat a case of tuberculosis, his Fed colleagues quickly hiked the discount rates charged to banks to 7% from 4.6%. Sharp deflation — prices fell 15.8% in the 12 months ending June 1921 — and an economic depression followed. This depression didn’t last long, and a few years ago market pundit James Grant wrote a book about it lauding the laissez-faire response of President Warren Harding (who took office in March 2021) and other officials. But the bigger lesson seems to be that it was probably unnecessary to begin with.

—Bloomberg

Justin Fox is a Bloomberg Opinion columnist covering business. He was the editorial director of Harvard Business Review and wrote for Time,
Fortune and American Banker. He is the author of “The Myth of the
Rational Market”