Inflation in the US after the Second World War - Term Paper Example

?Inflation in the US after the Second World War Introduction The US has seen continuous inflation ever since the end of the Second World War. It is hard to find a similar period with such a continuous inflation in the history of America before the Second World War. In fact, the country has seen long periods of deflation before the Second World War. The last economic expansion took place between March 1991 and March 2001 when the rate of inflation was low by the standards of the post Second World War era, which holds true irrespective of the kind of index used to calculate the rate of inflation. A low rate of inflation is particularly significant because the economy of the US was at least fully employed as per the estimates for the last three years of the last economic expansion period. However, little tendency of acceleration has been noticed in the inflation rate. It is difficult to have such a policy task that keeps the economy moving along the full path of employment with no burst of inflation happening as a result. Since the costs of labor are almost two-thirds of the total costs of production, the rate of rise is considered to be an indication of inflation in future at the retail level. The rates rose in the latter stage of the last economic expansion while they were moderate in the contraction, recovery, and expansion subsequently. The profile of inflation in the US While Europe experienced catastrophic inflation before the Second World War, the US has mainly seen three periods of inflation that generated huge economic concern since 1913; the first of these periods was from 1915 to1920 when prices almost doubled, the second period ranged from 1945 to 1947 during which, 34 per cent increase was noticed, and the third period ranged from 1972 to 1982 during which, a total of 131 per cent increase was noticed (Economy In Perspective, 2010). The worst 5 years of inflation in the history of America after the Second World War were 1946, 1974, 1975, 1979, and 1980 with the average real returns being 12.23 per cent from stock in those years (Gold-Eagle, 2001). While the deficit and debt massively increased during the 1980s, inflation was controlled. A very good period for the financial assets was the 1990s, but major changes were brought to the world economy in the 21st century. Although there has been no significant inflation in the US for the past few years, yet it does not imply that inflation cannot increase in the future. Eventual increase in the demand for loans by businesses and households is addressed by the commercial banks. While the consequential increased spending growth by businesses and households is first welcomed, it might lead to unwanted inflation in the long run (Feldstein, 2013). Causes of inflation Practically, the US has never experienced a period in its entire history when a change in the level of price was not accompanied with a simultaneous change in the money supply. This forms the basis of the view widely held according to which, inflation is a monetary phenomenon everywhere and always that happens as a result of rise in the monetary quantity relative to the output. In spite of the general consensus held by economists over this view, it is consistent with two very different views over the cause of inflation. According to the first view, rapid growth of money causes inflation and is itself caused from Federal Reserve’s mistaken policies. Inflation is controlled by the Federal Reserve and the control is determined by the willingness of the Federal Reserve to constrain the money supply growth. The alternative view is based on the belief that prices experience a major upward pressure because of the activities that cause a decline in the real output. Organized labor’s attempt to acquire increase in the real wages is a favorite candidate. Other activities include the OPEC’s monopolistic pricing behavior, changes in the international trade terms because of decline in dollar’s foreign exchange rate, and major crop failures. Decline in output caused by such activities generally causes the unemployment to rise. To deter the increase of unemployment, the Federal Reserve pumps the demand up by simplifying the money supply growth. It ratifies increase in the price level in this process. Although the money supply growth is required for the ratification of upward movement of the price level, it does not cause price increase. If the Federal Reserve does not expand the demand while the unemployment is increasing, it would cause a decline in costs, wages, and prices in general. The output goes back to its previous level in the long run and the only difference would be in the relative prices and wages. Although the Federal Reserve can curb inflation, yet it generally does not use this power because of the runup caused in unemployment. On the other hand, if the Federal Reserve does not expand money to increase the demand as developments reducing output take place, this would lead to emergence of money substitutes that would allow the growth of demand and ratification of the price increases. This variation precludes excessive growth of money from causing inflation because the Federal Reserve does not force excessive money over the economy. In such a case, excessive money does not chase too few goods in inflation. Inflation in the US in presidential terms Among all economic numbers, association of inflation with presidential administrations is the most difficult to draw because the principle responsibility for inflation rests with the Federal Reserve. The following graph shows the last two periods of considerable inflation in the history of the US in presidential terms: “Average Annual Inflation Rate per Presidential Term” (Economy in Perspective, 2010). From the above graph, it can be inferred that Carter’s period stands out among all presidents in terms of a very critical time with inflation. The only eras to come close were the first term of Truman and Nixon/Ford era. Other than these, no president has had such a great trouble with inflation as it was well controlled in the first term of Reagan. The highest inflation rate experienced after the Second World War was during Truman’s presidency, though it was controlled efficiently. The problem of inflation remained persistent during the 1970s when as many as four presidents had to deal with it, namely Nixon, Ford, Carter, and Reagan. The individual that generally had the maximum control over inflation was the Chairman of the Federal Reserve. Arthur Burns was the Chairman of the Federal Reserve between 1970 and 1977. He was concerned that unemployment might increase if harsh measures were taken in an attempt to quell inflation. Jimmy Carter dealt with inflation as one of the biggest issues. George Miller, Chairman of the Federal Reserve appointed by Carter was criticized for the shortsightedness of his credit policies which resulted in aggravation of inflation, which was later controlled by Paul Volker. Explanation of the profile of inflation rate in different presidential eras In spite of the varying economic policies, the relative absence of inflation can be attributed to placement of inflation rate beyond the political control by the Federal Reserve. There was little correlation of the inflation periods with the level of debt. While Truman experienced inflation during a high debt level, the problem was addressed while the debt was almost the same as the GDP. Debt was the lowest in terms of proportion of GDP during the 1970s when the US saw the worst inflation since the Second World War. Political leaders always have tended to take the view that in time of war the nation must do whatever is necessary to succeed, and the financial repercussions can be dealt with later. Johnson was only following the pattern that had been adhered to by his predecessors: Lincoln during the Civil War, when inflation in the Union from 1861 to 1865 was 117%; Wilson during World War I, when prices rose from 1917 to 1918 by 126%; and Roosevelt during World War II, when prices rose from 1941 to 1945 by 108%. (Shelton, 2009, p. 67). Conclusion The US saw a runup of inflation in the late 1960s and 1970s. This runup was caused because of the belief of the monetary authority that the trade-off between employment and inflation was exploitable. These beliefs paved way for acceptance of the temptation to inflate on the part of the monetary authority until the time-consistent inflation rates were obtained. Inflation after the Second World War was at its worst in the years 1946, 1974, 1975, 1979, and 1980. Dynamics of inflation and unemployment are driven by the exogenous drift in the natural unemployment rate such as demographic changes. Analysis of the profile of inflation rate in the US during different presidential eras suggests that while the importance of economic policy in depicting the rate of inflation cannot be overemphasized, Democrats and Republicans hold different perceptions over the best economic policy to control inflation. The economy of the US performed better during the presence of the democrats in the oval office compared to the republicans. References: Economy In Perspective. (2010). Inflation. Retrieved from http://economyinperspective.com/inflation. Feldstein, M. (2013, June 28). Why Is US Inflation So Low? Retrieved from http://www.project- syndicate.org/commentary/the-inflationary-risk-of-us-commercial-bank-reserves-by-martin-feldstein. Gold-Eagle. (2001). War and Inflation. Blanchard Economic Research. Retrieved from http://www.gold-eagle.com/article/war-and-inflation. Shelton, J. (2009). Money Meltdown. Simon and Schuster. Read More