News that Rishi Sunak is planning a summer mini-budget conjures up memories of the 1970s when chancellors were constantly forced to respond to the latest economic crisis.
Sunak is finding out what it was like to be Tony Barber or Denis Healey, who ran the treasury from 1970 to 1979. To be sure, that decade seems to be a more relevant reference point than the 16 years between 1992 and 2008 when the economy expanded continuously and inflation was low. That now looks like an aberration rather than the start of a new golden age.
As was the case when Barber and Healey were announcing their emergency packages, Rolls-Royce, one of the UK’s biggest manufacturers, is struggling. Ministers are contemplating taking a stake in strategically important companies to stop them going bust. Sunak is forever popping up to announce the latest changes to his furlough scheme amid fears of mass unemployment. There is bitter argument over Europe and much loathing of the occupant of the White House. Substitute power cuts for social distancing rules, the three-day week for the lockdown, and Richard Nixon for Donald Trump and the picture seems complete.
Not quite, though. For the full 1970s experience, there needs to be stagflation – weak or falling activity combined with rapidly rising prices – of the sort that gripped most western economies after the oil price rocketed in 1973. Even though inflation is currently low, there are economists who think there is a real possibility of it happening.
Here’s how a potential stagflation scenario unfolds. At the moment, demand for goods and services is weak because people have been confined to their homes and can only spend their money on essentials or by shopping online. But money is cheap and plentiful, while the government’s wage subsidies – mirrored by similar schemes in other countries – have protected incomes. The result will be a splurge of pent-up spending once the pandemic is over.
Consumers will find, however, that the supply of goods and services has been hit badly by the lockdown. Firms will either have gone bust or will be operating for the foreseeable future under rules that will limit their capacity. Demand will exceed supply, and with too much money chasing too few goods inflation will go up. Workers will respond to higher prices by seeking higher pay and a wage-price spiral will ensue. Growth is weak but upward pressure on the cost of living is strong. Bingo: stagflation.
As Rob Carnell, an economist at ING bank has pointed out, a bit of 1970s-style stagflation would not be a bad thing in the current circumstances because it would inflate away the real value of record levels of both private and public borrowing. “With debt ratios hitting previously unimaginable highs, it could be an outcome to grab with both hands, not to recoil from in horror,” Carnell says.
But as he also points out, this is not not an especially likely scenario. Much the same argument was made at the time of the global financial crisis a decade ago, when it was said that the vast amount of money creation undertaken by central banks through quantitative easing – the buying of bonds in return for cash – would end in the sort of hyper-inflation seen in Germany in the 1920s.
As it turns out, central banks have spent most of the past decade concerned that inflation is too low rather than too high. Fears that the steady fall in unemployment would enable workers to pursue inflationary wage claims have proved unfounded. A decade of QE and ultra-low interest rates did lead to stagflation, but not the sort that was expected. Wages stagnated but the price of assets – commodities, shares, bonds and property – all inflated.
The early stages of the current crisis suggest history might repeat itself. Financial markets have, so far, been the real beneficiaries of central bank activism that dwarfs anything seen in 2008-09. The Federal Reserve, the US central bank, has been unable to prevent 40 million Americans filing jobless claims in the past two months, but it has succeeded in boosting share prices on Wall Street.
For a classic wage-price spiral to develop, two things would need to happen. Firstly, employees would have to see their living standards eroded. Secondly, they would need to be able to do something about it.
Without question, millions of people around the world are going to feel poorer as a result of Covid-19. Even those benefiting from the furlough scheme in the UK will have taken a 20% pay cut all the time they remain off work, and there will be plenty of workers – including many of the self-employed – who will be even worse off. It is not just the supply side of the economy that will take a hit: demand will be softer as well.
In the 1970s, workers were in a much better position to do something about the squeeze on their incomes than they are today. Manufacturing accounted for more of the economy and trade union membership was high in Britain’s factories. Many industries were state owned and domestic suppliers were more shielded from foreign competition. There was no such thing as the gig economy. Ted Heath’s government introduced threshold agreements under which workers were guaranteed wage rises when inflation rose above a certain level.
Unions are weaker than they were in the 1970s and employers are stronger. Sunak could use his mini-budget to push through an above-inflation increase in the minimum wage but will be under pressure from business not to do so. Unemployment is about to rocket and the threat of being laid off will mean whatever limited bargaining power workers have will be reduced. It’s hard to see where stagflation comes from.