6.3 How the U.S. and Other Countries Experience Inflation

Historical Inflation in the U.S. Economy

Figure 6.3 (a) shows the level of prices in the Consumer Price Index stretching back to 1947. In this case, the base years (when the CPI is defined as 100) are set for the average level of prices that existed from 1982 to 1984. Figure 6.3 (b) shows the annual percentage changes in the CPI over time, which is the inflation rate.

 

Going further back in US history we would see two waves of inflation right after World War I and World War II, as well as two periods of severe negative inflation—called deflation—in the early decades of the twentieth century: one following the deep 1920-21 recession of and the other during the 1930s Great Depression of the 1930s. (Since inflation is a time when the buying power of money in terms of goods and services is reduced, deflation will be a time when the buying power of money in terms of goods and services increases.) For the period from 1900 to about 1960, the periods of major inflation and deflation nearly balanced each other out, so the average annual rate of inflation over these years was only about 1% per year. A third wave of more severe inflation arrived in the 1970s and departed in the early 1980s.

Visit bls.gov or FRED to check the most recent developments in the US rate of inflation. During the period from January 2021 to January 2022 the US experienced it’s highest inflation rate in over 40 years with a 7.5% inflation rate based on the consumer price index. The two possible explanations for the recent period of high inflation were supply chain issues associated with the global COVID-19 pandemic and the issuance of too much fiscal stimulus during the pandemic which caused a surge in demand. Most likely history will show that it was some combination of those two things.

Times of recession or depression often seem to be times when the inflation rate is lower, as in the recession of 1920–1921, the Great Depression, the recession of 1980–1982, and the Great Recession in 2008–2009. There were a few months in 2009 that were deflationary, but not at an annual rate. High levels of unemployment typically accompany recessions, and the total demand for goods falls, pulling the price level down. Conversely, the rate of inflation often, but not always, seems to start moving up when the economy is growing very strongly, like right after wartime or during the 1960s. The frameworks for macroeconomic analysis, that we developed in other chapters, will explain why recession often accompanies higher unemployment and lower inflation, while rapid economic growth often brings lower unemployment but higher inflation.

Inflation around the World

Around the rest of the world, the pattern of inflation has been very mixed; Figure 6.4 shows inflation rates over the last several decades. Many industrialized countries, not just the United States, had relatively high inflation rates in the 1970s. For example, in 1975, Japan’s inflation rate was over 8% and the inflation rate for the United Kingdom was almost 25%. In the 1980s, inflation rates came down in the United States and in Europe and have largely stayed down.

Countries with controlled economies in the 1970s, like the Soviet Union and China, historically had very low rates of measured inflation—because prices were forbidden to rise by law, except for the cases where the government deemed a price increase to be due to quality improvements. However, these countries also had perpetual shortages of goods, since forbidding prices to rise acts like a price ceiling and creates a situation where quantity demanded often exceeds quantity supplied. As Russia and China made a transition toward more market-oriented economies, they also experienced outbursts of inflation, although we should regard the statistics for these economies as somewhat shakier. Inflation in China averaged about 10% per year for much of the 1980s and early 1990s, although it has dropped off since then. Russia experienced hyperinflation—an outburst of high inflation—of 2,500% per year in the early 1990s, although by 2006 Russia’s consumer price inflation had dipped below 10% per year, as Figure 6.5 shows. The closest the United States has ever reached hyperinflation was during the 1860–1865 Civil War, in the Confederate states.

Figure 6.5 (a) Countries with Relatively High Inflation Rates, 1980–1995 These charts show the percentage change in consumer prices compared with the previous year’s consumer prices in Brazil, China, and Russia. Of these, Brazil and Russia experienced very high inflation at some point between the late-1980s and late-1990s. (Source: https://fred.stlouisfed.org/graph/?g=Otq5)

In the early 2000s, the problem of inflation appears to have diminished for most countries, at least in comparison to the worst times of recent decades. As we noted in this earlier Bring it Home feature, in recent years, the world’s worst example of hyperinflation was in Zimbabwe, where at one point the government was issuing bills with a face value of $100 trillion (in Zimbabwean dollars)—that is, the bills had $100,000,000,000,000 written on the front, but were almost worthless. In many countries, the memory of double-digit, triple-digit, and even quadruple-digit inflation is not very far in the past.