Inflation: policy lessons from the 1920s

August 12, 2022 | Blog
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by Aaron Jacob

The author was previously a District Councillor in St Albans. He holds a Masters degree in Modern History from the University of St Andrews and a Masters degree in Politics from King’s College, London.


It is trite to say that the macroeconomic problem today is inflation. Advanced Western economies have emerged from the COVID-19 pandemic to find consumer price inflation at levels not seen for forty years. Central banks have started to respond, albeit belatedly, with the conventional toolkit: raising interest rates. Although logical, proceeding too tightly, too quickly, will push the economy back into recession. Thankfully, history provides us with lessons as to what not to do at this critical juncture.


It is often said that the most reliable stimulant of historical research is the desire to learn from the past. Too often, though, the commentariat reaches for recent parallels which are not really parallels at all. The stagflation of the 1970s, so the story goes, is akin to the circumstances we currently confront. Difficult industrial relations, with powerful union barons, conspired to drive wages higher, in a process that was compounded by an oil price shock. A wage-price spiral resulted in inflation in the UK reaching a level never seen before, nor since, peaking at 25 per cent. Growth, meanwhile, staggered, as industrial obsolescence and a failed dose of Heath’s dirigisme failed to return Britain to its immediate post-war halcyon days of low unemployment, tolerable inflation, and high growth. The simplicity of this narrative fails to take account of the government’s incomes policy at the time, nor does it say anything of the rate of the current price rises. Perhaps this period is a convenient comparator because it lay within living memory, but the application of its lessons to today is questionable.


This is why we must consider the importance of the 1920s. The 1920s are not, generally, thought of as particularly significant in the annals of economic history. It is often pipped by the 1930s, the ‘Devil’s decade’, with its unprecedented levels of unemployment and the consequent rise of fascism on the continent. Yet the 1920s, before they were ‘Roaring’, started out as one of slumber and dislocation. Then, as now, the First World War had been followed by an inflationary boom. Wages had risen faster than prices in the last two years of the war, but rationing had prevented people from spending their increased money wages on consumption goods. With the removal of government controls, the public went on a spending spree, and prices rose by some 50 per cent between April 1919 and April 1920. Britain was temporarily off the gold standard, and money seemed to flow like water. As the underlying basis for financial policy was ultimately a return to gold, as outlined in the Cunliffe Report of 1919, orthodoxy had it that ‘dear money’ was the solution. Even John Maynard Keynes, no friend of deflation, when consulted, expressed that the bank rate should be increased to 10 per cent if necessary and held there for as long as required to break the boom. Then, as now, conventional monetary policy reverted to tried and tested methods.


The government of the day obliged—but too timidly and too late. The bank rate was increased to 7 per cent in April 1920 and held there for a year. That same month, the government imposed new taxes to increase an already substantial budget surplus. The government of the day thought that it could deflate the economy without causing a depression. With monetary and fiscal policy both being contractionary, the results were nothing short of extraordinary. Nothing like this collapse of output, prices, and employment had been experienced since the Napoleonic Wars. Real GDP in Britain is estimated to have fallen by 23 per cent between the third quarter of 1920 and the second quarter of 1921, and it did not regain its previous high until the second quarter of 1924. Wholesale prices, meanwhile, fell by about 25 per cent between 1921 and 1929. Once the pin was pricked, unemployment resulted, and failed to disappear for the rest of the decade, with recorded unemployment hovering above 10 per cent throughout the 1920s.


The lessons for today are clear to those who wish to learn them. In a period of demand colliding with constrained supply, the Bank of England should have imposed disinflation much sooner. This should have started with ending a quantitative easing programme whose consequences have been nothing but distortive to capital allocation. The Monetary Policy Committee (MPC) seems, too, to have forgotten Nelson’s dictum that ‘the boldest measures are the safest’. They should have proceeded with larger rate rises, perhaps as early as in April 2021. Too timid, too late characterized the response in 1920. Too timid, too late has characterized the response in our own time. Timing, expectation management, and clarity over next steps should equally form part of the Bank of England toolkit.


The 1970s are a useful reference point if one were conducting a rough and ready analysis. But, if the Bank of England were to analyse the current circumstances clearly, they would see that the immediate period after the First World War holds many of the answers to the current malaise. The solution was but a mirror for today, and the solution for today’s difficulties had already been worked out a century ago. Go early, and when you do, be bold. History always contains useful lessons. The consequences for today may be no different to the early 1920s if those lessons are not learnt.



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