Could we be headed for a repeat of the 1970s-era stagflation where there was double-digit inflation and slowing growth? Based upon the February 2022 Bureau of Labor Statistics release, total U.S. inflation rose 7.99% from a year ago, marking the largest increase since 1982. Rising prices are likely a result of pandemic-related supply chain issues, monetary policy, geopolitical tensions, and a tight labor market. Furthermore, some analysts see inflation remaining far above the Fed’s long-term target level (~2%) for some time.
While comparing 1970s stagflation with today’s elevated inflation, there are several differences between the two periods.
- While both inflationary periods were driven by supply shocks, the current problem is further exacerbated by expansionary monetary policy, and a demand surge following the pandemic shutdown. In the 1970s, inflation was spurred by high energy prices and oil embargoes.
- During 1970s stagflation, economic activity outpaced productive capacity. By comparison, the current economy still has excess productive capacity, according to Jean Boivin, head of the BlackRock Investment Institute. He believes that supply will eventually rise to meet demand, compared to the 1970s, where demand went down to meet supply.
- Geopolitical tensions led to dual-energy shocks in the 1970s, with annual surges in oil prices of more than 300% year over year in 1974 and 180% in 1979. While we are also facing geopolitical conflicts fueling the increase of oil prices today, the increase in oil prices has not yet reached the triple digits: the average monthly price of Brent crude oil is projected to rise to an average of $113 per barrel in March 2022, up from $65 in March 2021. This 74% annual increase is less dramatic than that seen in 1974. Furthermore, President Biden announced on March 31, 2022, that he has authorized the release of up to 1 million barrels of oil per day from the strategic petroleum reserve. In theory, this order should mollify energy price increases in the short term.
Stagflation in the 1970s was correlated with higher unemployment and recessions.
- Higher unemployment was also a part of stagflation in the 1970s with unemployment rates at the mid-to-high single digits during that decade, rising to over 10% in 1982. By contrast, today’s labor market is stronger, with the unemployment rate dropping from January’s 4.0% to a two-year low of 3.8% in February 2022.
- While there were two recessions in the 1970s, 2022 GDP growth is forecasted to be 3.7%. Forecasters surveyed by the Federal Reserve are also projecting positive, albeit moderating, economic growth for the next two years, with 2.7% GDP growth in 2023 and 2.3% in 2024.
- In the 1970s there was a lag between the beginning of the recession and a notable uptick in unemployment. When the recession began in 1970, the unemployment rate was 6.1%. From 1971 through 1973, the rate actually fell to 4.9% before rising to 7.2% in 1974 when Nixon resigned. It still ticked higher to 8.2% in 1975, when the recession officially ended.
Where are we in the inflation cycle?
Going forward, a few factors could act as a headwind to inflation. The projected slower economic growth after this year could result in less inflation. The Fed has already become more hawkish and began rate hikes in March 2022. The Fed is trying to find a balance between managing growth at a reasonable pace and taming inflation. However, the future of energy prices is an unknown. Commodity prices are expected to continue moving higher.
Furthermore, the recent conflicts in Europe could also contribute to higher inflation. After the conflict between Russia and Ukraine began, food and oil prices rose. If oil stays above $100 a barrel, and the Commodity Research Bureau Food Index (a measure of global commodity prices) increases 35% from the end of 2021, the consumer price index could add 1.3 percentage points in 2022, according to economists at Wells Fargo. Russia and Ukraine accounted for over 25% of global wheat exports in 2019. The two countries also supplied about 20% of the world’s barley and corn. If exports of these important crops are restricted for an extended time, it could fuel food price increases. Russia is also the largest exporter of fertilizers globally, accounting for 21% of all potash and 23% of ammonia exports. Disruptions could drive up prices for U.S. farmers, which would impact food prices.
While the Fed has already begun rate hikes, it is less likely to be overly aggressive in tightening, risking an inverted yield curve and potential recession. Given that GDP growth is projected to decrease in 2022 and 2023, if rates were to rise too quickly, there could be a risk of stagnation. Even with the recent rate hikes, there tends to be a lag of six to twelve months before the economy is affected.
Overall, insurers and brokers should prepare for a continued period of elevated inflation while keeping an eye on economic data that influence the Fed. Higher than anticipated inflation could impact reserve levels and underwriting profitability for the insurance industry. With increased inflation comes the worry that property-casualty insurers’ claims costs could exceed reserves if reserves were established with much lower inflation assumptions. However, industry reserves are in a much stronger position now than they were in the 1970s. Furthermore, the tighter job market could continue for months, as changes in the unemployment rate typically lag inflation and GDP growth.
If you have questions about Today’s ViewPoint, or would like to learn more about how MarshBerry can help your firm plan for its future, please email or call Gerard Vecchio, Managing Director, at 212.972.4886.
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