As a teen, I was always excited for the return of track practice. After being cooped up all winter, I had high hopes of putting in the miles and setting personal records. After a few days of conditioning, however, the pain of lactic acid quickly reminded my legs that they had plenty of work ahead. Moving from a dormant state to physical activity is not easy, but it is like our current economic condition.
Current reports of inflation remind us of German peasants exchanging wheelbarrows of marks for loaves of bread during the hyperinflation of the 1920s or the difficult stagflation era of high unemployment and prices caused by the OPEC oil embargo in the 1970s. These examples fundamentally miss the mark in describing our current economic climate, however. A better example is to consider the years directly following World War II.
Unlike in financial or banking crises, savings and wealth simply are not lost during a national crisis. During World War II, Americans mobilized the “arsenal of democracy” by switching production from automobiles to tanks and planes. This pivot reduced the supply of durable consumer goods on the home front. Industry also struggled to find labor since most young males were either fighting in Europe or the Pacific. Both headwinds caused an increase in prices for everyday purchases. To avoid accusations of war profiteering, President Franklin D. Roosevelt instituted price control which exacerbated widespread shortages.
After their victory over fascism and imperialism, soldiers came home looking forward to a sense of normalcy (not unlike our current hangover after a two-year pandemic). Enabled by the GI Bill, easy employment and raising wage rates, the demand for vacations, cars and housing skyrocketed.
However, just like high school athletes experience the discomfort of lactic acid after slacking off during the off-season, there are substantial growing pains in transitioning a wartime economy to peace. Factories face labor shortages, production lines are out of sorts, and supply chains no longer hold in the face of unsatiated demand from would-be consumers. After World War II, these forces combined for inflation rates that at times exceeded 20%, more than double our current inflation rate of 7.9%.
Why is this so important? Because like a physician prescribing the right treatment to a patient, it is incredibly important to diagnose the current inflation fever correctly. Unlike Germany, Austria and Poland during the interwar period (10,000% annualized) or the oil crisis of the 1970s (14%), this inflation is coupled with a booming economy and a declining unemployment rate. Fiscal policy increased spending and provided direct cash transfers to households. However, many households used these checks to save, pay down debt or continue paying bills during unemployment spells. The Census Bureau estimates that only 19% of the third stimulus checks went to consumption.
In the short run, as an economy transitions out of a stressed state to something more akin to its long-run potential, resources and infrastructure begin to bind, and workers return to jobs as production ramps up again. However, since people are sick of being stuck at home balancing remote work and their kids’ disrupted schooling, the economy is facing a double serving of consumer demand, driving up the prices. Gas prices are low when no one can travel, but skyrocket when everyone wants to be on the road again.
The columnist George Will often says that the first rule of economics is life is about tradeoffs, but the first rule of politics is to ignore economics. Inflation becomes more salient as unemployment plunges and voters forget the pain of job loss as their purchasing power declines. Policymakers must wisely manage a tradeoff between price stability and employment. Voters should view political candidates who promise them low prices at no economic expense with the healthy skepticism given a modern-day hair growth elixir.
As the Federal Reserve begins to sell the assets obtained during the pandemic, the money supply will decrease and interest rates will increase. This balance-sheet unwinding will decrease prices but increase the cost of doing business. While a necessary correction, it too will require tradeoffs from all of us. Some turbulent times lie ahead, but we have seen this before and should face it with a steely eye and a dash of optimism.
Michael S. Kofoed, @mikekofoed on Twitter, is an associate professor of economics at the U.S. Military Academy and a research fellow at the Institute of Labor Economics. A Utah native, he holds degrees in economics from Weber State University and the University of Georgia. These opinions are those of the author and do not represent the U.S. Military Academy, the Department of the Army or the Department of Defense.