Inflation and the business cycle during the postwar period Essay

Inflation in both retail and primary markets has remained relativelylow despite the rapid growth in economic output since the trough of thelast recession in November 1982. In the ensuing 22 months of thecurrent expansion, consumer prices have advanced at a 3.6-percentseasonally adjusted annual rate, with the 3 months ended in Septemberincreasing at a seasonally adjusted annual rate 4.5 percent. In thisarticle, we describe the behavior of prices in the current and previousbusiness expansions and examine some of the major factors associatedwith those changes. It is our objective to provide historical contextand perspective within which the reader may evaluate current pricebehavior and forecasts. In the post-World War II period, the U.S.

economy has undergoneeight recessions in business activity. While these periods have evolvedfrom different initial conditions, extended over varying periods ofduration, and been subject to different external shocks and economicpolicies, they have been characterized by similarities in thequalitative behavior of prices. Table 1 summarizes the behavior ofseveral measures of consumer price change for the recession peaks andtroughs, and at selected dates of the subsequent business expansion.

Tables 2 and 3 present selected changes in producer prices and laborcosts for the same times. The first seven columns of the tables providethe data for each of the first seven recessions and expansions in thepostwar era. The eighth column of data is the average of all sevenrecessions and expansions prior to the most recent. The ninth column isthe average of the first six periods, because the expansion after the1980 recession was only 12 months long. Consequently, the”expansion” measures for that period extend into thesubsequent recession. The 1981-82 recession. At the trough of the 1981-82 recession, theConsumer Price Index for All Urban Consumers (CPI-U) was increasing at aseasonally adjusted annual rate of 1.

7 percent. (See table 1.) Thedeceleration in prices had begun, in the fourth quarter of 1981, shortlyafter 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 bythe fact that the homeowner cost portion of the CPI-U was changed to arental equivalence basis in January 1983. To facilitate comparisons, weinclude in table 1 parenthetical data for the 1981-82 recession based onthe rental equivalence prototype. That index (CPI-U, XI) essentiallyshows much less deceleration during the recession but a further drop ininflation since then. After 22 months of economic expansion, pricechanges are still moderate. The is consistent with postwar experience. Consumer prices. Examining four major categories of the CPI, wesee that food prices moderated before prices of shelter, energy, and aresidual factor–all items less food, shelter and energy.

After”double digit” increases in the last 2 quarters of 1980, foodprices decelerated in the first quarter of 1981 and were increasing atonly 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 a1.5-percent rate. Despite the impact of the Federal payment-in-kind(PIK) farm program, the 1983 summer drought and the early winter freezein 1984, food prices have continued to register generally moderateincreases. Energy prices began to slow down after March 1981. Prices forpetroleum-based items had risen sharply in the first quarter of 1981 dueto announced price increases by the Organization of Petroleum Countries(OPEC) and domestic price decontrol. These increases, combined with aslowdown in economic activity, led to a reduction in the demand for oiland an oversupply of petroleum and generally lower prices for petroleumproducts.

However, prices for both natural gas and electricity wereadvancing at “double-digit” rates just prior to the recession.Charges for electricity began to slow in the second quarter of 1982, butnatural gas prices continued to increase sharply through the firstquarter of 1983. By the trough of the recession, however, the overallenergy component had moderated.

So far in 1984, energy prices havecontinued to exert a moderating effect on the overall CPI. Shelter costs in the period to the recession trough were dominatedby the behavior of house prices and mortgage interest rates. Theincrease in house prices had slowed early in 1981 and shelter costs wereadvancing only slightly at the business cycle peak.

Interest rates,however, had continued to advance until 1982. A very sharp drop inmortgage interest in the fourth quarter of 1982 produced decliningshelter costs at the end of the recession. As indicated earlier, amajor conceptual change in the treatment of homeowner costs, andconsequently, shelter costs, was introduced in January 1983. The newrental equivalence measure of homeowner costs shows less volatility thanthe former asset approach.

Comparing the present official measure inSeptember 1984 with the former official measure overstates theacceleration since the recession trough. A shelter component with arental equivalence measure was not available, but homeowner costs (theonly component within shelter affected by the conceptual change) in theexperimental CPI-U, XI were increasing at a 7.6-percent rate in November1982, 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 ofinflation–exhibits more classical price behavior than the other groups.The maximum rate occurred at the peak of the business cycle and the rateof increase decelerated smoothly until turning slightly upward shortlyafter the trough of the recession. As of September 1984, however, therate was still below that of the trough of the recession. Producer prices. The Producer Price Index (PPI) is structured bystages of processing: crude materials, intermediate materials, andfinished goods.

In July 1981, at the peak of the business cycle, pricesfor crude materials were still rising at double-digit levels, whilethose for intermediate materials and finished goods had just deceleratedfrom these levels. Sixteen months later, at the trough of the cycle,prices for crude materials were declining while prices for intermediatematerials and for finished goods were advancing at less than theprerecession rate. Twenty-two months into the expansion, crude materialand intermediate material prices are now declining slightly (down 0.5percent and 1.9 percent, respectively) and finished goods prices arestable. Preceding recessions 1948-49 recession. The first post-World War II recession followeda period of rapid expansion and inflation.

In November 1947, the CPIwas increasing at a 12.4-percent annual rate, but 12 months later, inNovember 1948, the prerecession peak, the CPI was declining at a4.3-percent annual rate. But the abatement of the boom did not bringwith it an accelerating decline in prices. At the trough, prices weredeclining, but at a slower rate than 11 months earlier. The recoveryfrom this mild recession was dominated by military developments. Afterthe outbreak of the Korean conflict in June 1950 and a return to adefense economy, output rose sharply and inflationary pressures wereevident. Consumer price increases lagged behind raw material prices,but by late 1950 they too were increasing at double-digit rates.

InJanuary 1951, price and wage controls were imposed. The CPI includedmany items for which controls were lacking, or were only partial, andwhile prices moderated, all major components continued to advance. Thelargest increases were in the service sector, reflecting increasedcharges for rents and medical and transportation services.

1953-54 recession. The contraction after July 1953 was largely inthe nature of an inventory adjustment. Producer prices peaked with thesharp increase in crude material prices triggered by the Korean conflictand had either declined or remained unchanged until 1955. Consumer priceadvances had also been moderate, even after price and wage controls hadbeen lifted. At the prerecession peak in July 1953, the CPI wasadvancing at an annual rate of only 1.5 percent. Ten months later, atthe trough of the recession, consumer prices were declining slightly,largely because of a drop in food prices. Increases in prices fornonfood commodities, reflecting the adjustment to decontrol, advancedmore 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 yearafter the first sharp increase in producer prices, the CPI accelerated.Advances in food prices, resulting from a decline in meat supplies, andin prices for services were primarily responsible. 1957-58 recession. A 4-percent of increase in the CPI was recordedfor both the prerecession peak and trough periods of the third postwarrecession. Double-digit increases in food prices, due to supplyshortages resulting from lower marketings of livestock and unfavorableweather conditions, were the principal reasons for the relatively largeadvances for these periods and the lack of a slowdown in the overall CPIduring the recession. At a point 22 months past the trough, however,consumer prices were increasing only slightly, as food prices finallybegan to slow substantially. Prices in the service sector wereincreasing at a significantly faster rate than those for commoditieswhich were, on average, unchanged.

Despite an advance in food prices,this was still the situation in April 1960, 24 months after the troughof the 1957-58 recession as well as the 1960-61 prerecession peak.Producer prices remained relatively stable from early 1958 through thebusiness cycle peak of the following recession. Thirth-four monthsafter the 1957-58 recession through, we were at the trough of the1960-61 recession. 1960-61 recession. At the cyclical peak before the 1960-61recession, the all-items CPI was increasing at an annual rate of 2.3percent. Food prices were rising at an annual rate 6.1 percent.

Pricesfor commodities other than food were declining, while service priceswere rising at a 4-percent rate. By the trough of the recession(February 1961), consumer prices were increasing at an annual rate ofless than 1 percent. All major components of the CPI had slowedsubstantially by the end of the recession. The ensuing recovery fromthis recession, the longest to date of the postwar period, was marked bygenerally stable prices through 1965, with only minor aberrations.Sharp increases in beef and gasoline prices in September 1962 werelargely responsible for the seemingly high rate 22 months after thetrough. These increases were temporary, as both beef and gasolineprices declined in the succeeding 12 months to a level lower than thatbefore the advance. Other than food, prices for commodities rose lessthan 1 percent annually from 1960 through 1965, while the service indexwas registering increases in the 2-percent range.

Prices at theproducer level were uniformly well-behaved until early 1965. 1969-70 recession. Consumer prices rose 6.1 percent in 1969, thelargest annual increase since 1947. The recession which began late in1969 caused the rate of inflation to subside only partially.

Nonfoodcommodities, which in the past typically responded to a weakening ofdemand, continued to advance without abatement. The services index alsorose steadily until credit markets eased and mortgage interest ratesdeclined in early 1971. Sharply reduced rates of increase in foodpricess were responsible for the modest deceleration between peak andtrough. Nine months after the trough, on August 15, a wage and pricefreeze was announced. The Phase I freeze and subsequent Phase IIcontrols were accompanied by lower inflation during the rest of 1971 and1972. Twenty-two months after the recession trough, prices had slowedto a 4.2-percent annual rate of increase. Coincident with thesubsequent easing of controls and the Arab oil embargo, consumer pricesstarted on an upward spiral in late 1972, less than 3 years from thebottom of the recession.

1973-75 recession. The business cycle peak of November 1973followed on the heels of the relaxation of price controls and the oilembargo. Consumer prices had advanced sharply and were accelerating.From December 1973 through January 1975, double-digit increases wererecorded by the CPI. By the recession’s end in March 1975, theoverall CPI was rising at an annual rate of 6.

6 percent. Although highby historical standards, this was still below the prerecession peak of8.2 percent, not to mention the intervening double-digit rates. Duringthe 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 ontheir higher energy costs. Twenty-two months into the economic recovery,prices were, on average, still moderating, but a few months later arapid rise in food prices and higher shelter costs temporarily reversedthe gains. The jump in food prices reflected adverse winter weather andits effect on fruit and vegatable supplies, as well as the delayedimpact of the July 1975 freeze on the Brazilian coffee crop.

1980 recession. The 1980 recession coincided with unprecedentedpeacetime inflation. At the prerecession peak (January 1980), consumerprices were surging at a 15.8-percent annual rate. While sharpincreases were recorded for energy, shelter, and food costs, the”underlying rate of inflation” was also advancing atdouble-digit rates. Six months later, at the bottom of the recession,prices were increasing at an 8.3-percent rate.

This slowdown was onlytemporary, as consumer prices continued to move up sharply until October1981, shortly after the start of the next recession. The currentoutlook The first six expansionary periods since World War II have, onaverage, shown a slowing of consumer price increases during the first 22months of recovery. By the 24th month of recovery, prices have onaverage begun to rise faster, returning to the rate of price change ofthe previous cyclical peak. While the average experience is for priceacceleration to set in after 2 years of recovery, there is noinevitability about the process.

Note, for example, the expansionsbeginning 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 conditionsplay a major role in determining the path prices take.

Those factorswhich affect the costs of production–such as material and laborcosts–and demand also shape the future pattern of price change. Whilecrude materials prices are currently down “0.5 percent) and pricesfor intermediate materials are also down (1.9 percent), prices forfinished goods are unchanged. Current measures of labor costs indicate a lack of immediatepressure on prices. The wage and salary component of the EmploymentCost Index, peaking in 1980, decelerated steadily through the secondquarter of 1984. Although the history of this series is short, its3.5-percent rate of increase is well below the experience of the lasttwo recoveries.

Another variable, unit labor cost, which relateschanges in labor costs to changes in output, declined in the secondquarter of 1984. This variable had registered increases of 7 and 5percent at the 1981-82 recession peak and trough periods. Thedeceleration between the recession trough and 22 months into therecovery is typical, but the magnitude–an actual decline in unit laborcosts–occurred only in the recovery from the 1960-61 recession. Recentmajor collective bargaining agreements and the pressure of foreigncompetition, derived in part from the rising value of the dollar onforeign exchange markets, would appear to preclude a sharp reversal inthese trends. However, in several recessions the runup in prices has not been acontinuous process, but a sharp jump in response to rapid contextualchanges. In two instances, military conflicts coincided with theacceleration and in two others, the vulnerability to a reduction in thesupply of petroleum triggered an inflationary spiral.

Such events are,of course, difficult to foresee.

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