Inflation and the business cycle during the postwar period Essay

Inflation in both retail and primary markets has remained relatively
low despite the rapid growth in economic output since the trough of the
last recession in November 1982. In the ensuing 22 months of the
current expansion, consumer prices have advanced at a 3.6-percent
seasonally adjusted annual rate, with the 3 months ended in September
increasing at a seasonally adjusted annual rate 4.5 percent. In this
article, we describe the behavior of prices in the current and previous
business expansions and examine some of the major factors associated
with those changes. It is our objective to provide historical context
and perspective within which the reader may evaluate current price
behavior and forecasts.



In the post-World War II period, the U.S. economy has undergone
eight recessions in business activity. While these periods have evolved
from different initial conditions, extended over varying periods of
duration, and been subject to different external shocks and economic
policies, they have been characterized by similarities in the
qualitative behavior of prices. Table 1 summarizes the behavior of
several measures of consumer price change for the recession peaks and
troughs, and at selected dates of the subsequent business expansion.
Tables 2 and 3 present selected changes in producer prices and labor
costs for the same times. The first seven columns of the tables provide
the data for each of the first seven recessions and expansions in the
postwar era. The eighth column of data is the average of all seven
recessions and expansions prior to the most recent. The ninth column is
the average of the first six periods, because the expansion after the
1980 recession was only 12 months long. Consequently, the
“expansion” measures for that period extend into the
subsequent recession.


The 1981-82 recession. At the trough of the 1981-82 recession, the
Consumer Price Index for All Urban Consumers (CPI-U) was increasing at a
seasonally adjusted annual rate of 1.7 percent. (See table 1.) The
deceleration in prices had begun, in the fourth quarter of 1981, shortly
after the business cycle peak in July. This price slowdown, of course,
was not uniform, either among types of items or stages of processing.
Analysis of the recovery period since November 1982 is complicated by
the fact that the homeowner cost portion of the CPI-U was changed to a
rental equivalence basis in January 1983. To facilitate comparisons, we
include in table 1 parenthetical data for the 1981-82 recession based on
the rental equivalence prototype. That index (CPI-U, XI) essentially
shows much less deceleration during the recession but a further drop in
inflation since then. After 22 months of economic expansion, price
changes are still moderate. The is consistent with postwar experience.



Consumer prices. Examining four major categories of the CPI, we
see that food prices moderated before prices of shelter, energy, and a
residual factor–all items less food, shelter and energy. After
“double digit” increases in the last 2 quarters of 1980, food
prices decelerated in the first quarter of 1981 and were increasing at
only a 4.5-percent rate at the peak of the business cycle in July 1981.
At the cyclical trough (November 1982), they were advancing at a
1.5-percent rate. Despite the impact of the Federal payment-in-kind
(PIK) farm program, the 1983 summer drought and the early winter freeze
in 1984, food prices have continued to register generally moderate
increases.



Energy prices began to slow down after March 1981. Prices for
petroleum-based items had risen sharply in the first quarter of 1981 due
to announced price increases by the Organization of Petroleum Countries
(OPEC) and domestic price decontrol. These increases, combined with a
slowdown in economic activity, led to a reduction in the demand for oil
and an oversupply of petroleum and generally lower prices for petroleum
products. However, prices for both natural gas and electricity were
advancing at “double-digit” rates just prior to the recession.
Charges for electricity began to slow in the second quarter of 1982, but
natural gas prices continued to increase sharply through the first
quarter of 1983. By the trough of the recession, however, the overall
energy component had moderated. So far in 1984, energy prices have
continued to exert a moderating effect on the overall CPI.


Shelter costs in the period to the recession trough were dominated
by the behavior of house prices and mortgage interest rates. The
increase in house prices had slowed early in 1981 and shelter costs were
advancing only slightly at the business cycle peak. Interest rates,
however, had continued to advance until 1982. A very sharp drop in
mortgage interest in the fourth quarter of 1982 produced declining
shelter costs at the end of the recession. As indicated earlier, a
major conceptual change in the treatment of homeowner costs, and
consequently, shelter costs, was introduced in January 1983. The new
rental equivalence measure of homeowner costs shows less volatility than
the former asset approach. Comparing the present official measure in
September 1984 with the former official measure overstates the
acceleration since the recession trough. A shelter component with a
rental equivalence measure was not available, but homeowner costs (the
only component within shelter affected by the conceptual change) in the
experimental CPI-U, XI were increasing at a 7.6-percent rate in November
1982, compared with 7.3 percent in September 1984.



The residual group–all items excluding food, shelter, and energy,
referred to by some analysts as the underlying rate of
inflation–exhibits more classical price behavior than the other groups.
The maximum rate occurred at the peak of the business cycle and the rate
of increase decelerated smoothly until turning slightly upward shortly
after the trough of the recession. As of September 1984, however, the
rate was still below that of the trough of the recession.



Producer prices. The Producer Price Index (PPI) is structured by
stages of processing: crude materials, intermediate materials, and
finished goods. In July 1981, at the peak of the business cycle, prices
for crude materials were still rising at double-digit levels, while
those for intermediate materials and finished goods had just decelerated
from these levels. Sixteen months later, at the trough of the cycle,
prices for crude materials were declining while prices for intermediate
materials and for finished goods were advancing at less than the
prerecession rate. Twenty-two months into the expansion, crude material
and intermediate material prices are now declining slightly (down 0.5
percent and 1.9 percent, respectively) and finished goods prices are
stable. Preceding recessions



1948-49 recession. The first post-World War II recession followed
a period of rapid expansion and inflation. In November 1947, the CPI
was increasing at a 12.4-percent annual rate, but 12 months later, in
November 1948, the prerecession peak, the CPI was declining at a
4.3-percent annual rate. But the abatement of the boom did not bring
with it an accelerating decline in prices. At the trough, prices were
declining, but at a slower rate than 11 months earlier. The recovery
from this mild recession was dominated by military developments. After
the outbreak of the Korean conflict in June 1950 and a return to a
defense economy, output rose sharply and inflationary pressures were
evident. Consumer price increases lagged behind raw material prices,
but by late 1950 they too were increasing at double-digit rates. In
January 1951, price and wage controls were imposed. The CPI included
many items for which controls were lacking, or were only partial, and
while prices moderated, all major components continued to advance. The
largest increases were in the service sector, reflecting increased
charges for rents and medical and transportation services.



1953-54 recession. The contraction after July 1953 was largely in
the nature of an inventory adjustment. Producer prices peaked with the
sharp increase in crude material prices triggered by the Korean conflict
and had either declined or remained unchanged until 1955. Consumer price
advances had also been moderate, even after price and wage controls had
been lifted. At the prerecession peak in July 1953, the CPI was
advancing at an annual rate of only 1.5 percent. Ten months later, at
the trough of the recession, consumer prices were declining slightly,
largely because of a drop in food prices. Increases in prices for
nonfood commodities, reflecting the adjustment to decontrol, advanced
more than those for services at both peak and trough periods.
Twenty-two months into the recovery, prices were rising slightly.
However, by April 1956, after 23 months of recovery and almost a year
after the first sharp increase in producer prices, the CPI accelerated.
Advances in food prices, resulting from a decline in meat supplies, and
in prices for services were primarily responsible.



1957-58 recession. A 4-percent of increase in the CPI was recorded
for both the prerecession peak and trough periods of the third postwar
recession. Double-digit increases in food prices, due to supply
shortages resulting from lower marketings of livestock and unfavorable
weather conditions, were the principal reasons for the relatively large
advances for these periods and the lack of a slowdown in the overall CPI
during the recession. At a point 22 months past the trough, however,
consumer prices were increasing only slightly, as food prices finally
began to slow substantially. Prices in the service sector were
increasing at a significantly faster rate than those for commodities
which were, on average, unchanged. Despite an advance in food prices,
this was still the situation in April 1960, 24 months after the trough
of the 1957-58 recession as well as the 1960-61 prerecession peak.
Producer prices remained relatively stable from early 1958 through the
business cycle peak of the following recession. Thirth-four months
after the 1957-58 recession through, we were at the trough of the
1960-61 recession.



1960-61 recession. At the cyclical peak before the 1960-61
recession, the all-items CPI was increasing at an annual rate of 2.3
percent. Food prices were rising at an annual rate 6.1 percent. Prices
for commodities other than food were declining, while service prices
were rising at a 4-percent rate. By the trough of the recession
(February 1961), consumer prices were increasing at an annual rate of
less than 1 percent. All major components of the CPI had slowed
substantially by the end of the recession. The ensuing recovery from
this recession, the longest to date of the postwar period, was marked by
generally stable prices through 1965, with only minor aberrations.
Sharp increases in beef and gasoline prices in September 1962 were
largely responsible for the seemingly high rate 22 months after the
trough. These increases were temporary, as both beef and gasoline
prices declined in the succeeding 12 months to a level lower than that
before the advance. Other than food, prices for commodities rose less
than 1 percent annually from 1960 through 1965, while the service index
was registering increases in the 2-percent range. Prices at the
producer level were uniformly well-behaved until early 1965.



1969-70 recession. Consumer prices rose 6.1 percent in 1969, the
largest annual increase since 1947. The recession which began late in
1969 caused the rate of inflation to subside only partially. Nonfood
commodities, which in the past typically responded to a weakening of
demand, continued to advance without abatement. The services index also
rose steadily until credit markets eased and mortgage interest rates
declined in early 1971. Sharply reduced rates of increase in food
pricess were responsible for the modest deceleration between peak and
trough. Nine months after the trough, on August 15, a wage and price
freeze was announced. The Phase I freeze and subsequent Phase II
controls were accompanied by lower inflation during the rest of 1971 and
1972. Twenty-two months after the recession trough, prices had slowed
to a 4.2-percent annual rate of increase. Coincident with the
subsequent easing of controls and the Arab oil embargo, consumer prices
started on an upward spiral in late 1972, less than 3 years from the
bottom of the recession.



1973-75 recession. The business cycle peak of November 1973
followed on the heels of the relaxation of price controls and the oil
embargo. Consumer prices had advanced sharply and were accelerating.
From December 1973 through January 1975, double-digit increases were
recorded by the CPI. By the recession’s end in March 1975, the
overall CPI was rising at an annual rate of 6.6 percent. Although high
by historical standards, this was still below the prerecession peak of
8.2 percent, not to mention the intervening double-digit rates. During
the recession, food, shelter, and energy price increases all slowed.
Prices for all other items, on average, however, actually accelerated,
reflecting in part the time lag associated with producers passing on
their higher energy costs. Twenty-two months into the economic recovery,
prices were, on average, still moderating, but a few months later a
rapid rise in food prices and higher shelter costs temporarily reversed
the gains. The jump in food prices reflected adverse winter weather and
its effect on fruit and vegatable supplies, as well as the delayed
impact of the July 1975 freeze on the Brazilian coffee crop.



1980 recession. The 1980 recession coincided with unprecedented
peacetime inflation. At the prerecession peak (January 1980), consumer
prices were surging at a 15.8-percent annual rate. While sharp
increases were recorded for energy, shelter, and food costs, the
“underlying rate of inflation” was also advancing at
double-digit rates. Six months later, at the bottom of the recession,
prices were increasing at an 8.3-percent rate. This slowdown was only
temporary, as consumer prices continued to move up sharply until October
1981, shortly after the start of the next recession. The current
outlook



The first six expansionary periods since World War II have, on
average, shown a slowing of consumer price increases during the first 22
months of recovery. By the 24th month of recovery, prices have on
average begun to rise faster, returning to the rate of price change of
the previous cyclical peak. While the average experience is for price
acceleration to set in after 2 years of recovery, there is no
inevitability about the process. Note, for example, the expansions
beginning in 1958 and 1961.



One reason for this dispersion in the historical record, of course,
is that the behavior of prices is not autonomous. Business conditions
play a major role in determining the path prices take. Those factors
which affect the costs of production–such as material and labor
costs–and demand also shape the future pattern of price change. While
crude materials prices are currently down “0.5 percent) and prices
for intermediate materials are also down (1.9 percent), prices for
finished goods are unchanged.



Current measures of labor costs indicate a lack of immediate
pressure on prices. The wage and salary component of the Employment
Cost Index, peaking in 1980, decelerated steadily through the second
quarter of 1984. Although the history of this series is short, its
3.5-percent rate of increase is well below the experience of the last
two recoveries. Another variable, unit labor cost, which relates
changes in labor costs to changes in output, declined in the second
quarter of 1984. This variable had registered increases of 7 and 5
percent at the 1981-82 recession peak and trough periods. The
deceleration between the recession trough and 22 months into the
recovery is typical, but the magnitude–an actual decline in unit labor
costs–occurred only in the recovery from the 1960-61 recession. Recent
major collective bargaining agreements and the pressure of foreign
competition, derived in part from the rising value of the dollar on
foreign exchange markets, would appear to preclude a sharp reversal in
these trends.



However, in several recessions the runup in prices has not been a
continuous process, but a sharp jump in response to rapid contextual
changes. In two instances, military conflicts coincided with the
acceleration and in two others, the vulnerability to a reduction in the
supply of petroleum triggered an inflationary spiral. Such events are,
of course, difficult to foresee.