Inflation before the oil shock

Tyler Cowen recently linked to an interesting William Fischel paper from 2016:

In the 1970s, unprecedented peacetime inflation, touched off by the oil cartel OPEC, combined with longstanding federal tax privileges to transform owner-occupied homes into growth stocks. The inability to insure their homes’ newfound value converted homeowners into “homevoters,” whose local political behavior focused on preventing development that might devalue their homes. Homevoters seized on the nascent national environmental movement, epitomized by Earth Day, and modified its agenda to serve local demands, thereby eroding the power of the prodevelopment coalition called the “growth machine.” The post-1970 shift in the American economy from industrial employment to knowledge-based services rewarded college graduates and regions that specialized in software and finance. Residents of suburbs in the larger urban areas of the Northeast and West Coast used existing zoning and new environmental leverage to protect the growth rate of their home values. The regional spread of these regulations has slowed the growth of the economy and perpetuated regional income inequalities. I argue that the most promising way to modify this trend is to reduce federal tax subsidies to homeownership.

1.  Consider it done.  The 2017 tax bill will lead to 60% fewer people using the mortgage interest deduction.  That didn’t take long!  Seriously, I do think this reform will help, but we should not expect miracles.  So far it doesn’t seem to have dramatically slowed the rate of appreciation in home prices, although it’s plausible that the increase would have been a bit faster without the tax change.

2.  The environmental movement did have some major successes, such as cutting air and water pollution.  But the requirement for “environmental impact statements” now seems like a major mistake, and indeed might actually hurt the environment by making it harder to build in major cities.

3.  Not to get too picky, but the idea that OPEC touched off the Great Inflation is a myth.  Here’s inflation before the oil shock of October 1973:

Screen Shot 2018-08-08 at 12.52.30 PM

During the early 1960s, inflation averaged a bit over 1%/year.  Monetary stimulus beginning in the mid-1960s pushed the rate up to 6% by the end of the decade.  A slightly tighter monetary policy led to a very small recession, and pushed inflation down to 4.3%.  Price controls then pushed (measured) inflation down to 3% in 1972.  But those controls were used by Nixon as cover to pump up NGDP growth to 9% right before the 1972 election.  By the third quarter of 1973, year over year NGDP growth was running at over 11%, and 12-month CPI inflation was up to 7.4%.  And this is all before the first OPEC oil shock.  It was a demand-side problem.

BTW, budget deficits also played no role in the Great Inflation, as they were quite modest during this period.  If budget deficits caused inflation, by 2019 we’d be well on our way to hyperinflation.  Overall, the Great Inflation was almost 100% monetary policy, even as year-to-year volatility was impacted by oil prices (after October 1973).

Despite these nitpicks, the Fischel abstract sounds basically correct to me—it’s a good way to frame the housing problem.




16 Responses to “Inflation before the oil shock”

  1. Gravatar of Marcus Nunes Marcus Nunes
    8. August 2018 at 10:13

    The oil shock of 1973 was more a consequence than the cause of inflation. (Remember oil price indexed to dollars, dollars loosing purchasing power, Sheiks had to maintain their large households!)

  2. Gravatar of B Cole B Cole
    8. August 2018 at 16:49

    Excellent blogging.

    By the way, I have been reading some old papers by Martin Feldstein, and I am absolutely convinced we should be now in a period of hyperinflation.

    On housing, I would like to see the federal government give to city governments huge cash bonuses for un-zoning property, based upon the population density of adjacent properties.

  3. Gravatar of E. Harding E. Harding
    8. August 2018 at 17:13

    I suggest using the PCE price index less food and energy, instead:

  4. Gravatar of ssumner ssumner
    8. August 2018 at 20:10

    Marcus, Good point.

    Harding, Also shows it began in the mid-1960s

  5. Gravatar of E. Harding E. Harding
    8. August 2018 at 20:40


    True, it was being noted around the 1968 election season, and Nixon didn’t put those price controls in for nothing.

  6. Gravatar of Jerry Brown Jerry Brown
    8. August 2018 at 20:42

    Ok, but going completely off the gold standard in 1971 did not play any part? Or the Vietnam War, which at least had to be some supply constraint while adding to demand- even if deficits were low?

  7. Gravatar of Meets Meets
    9. August 2018 at 09:01

    So Trump did something ok after all!

    I hope he continues to reduce MID and SALT.

  8. Gravatar of Doug M Doug M
    9. August 2018 at 13:25

    Can you attribute the acceleration in inflation to a flawed interpretation of the Phillips curve? It was thought possible to “buy” lower unemployment at the cost of higher inflation. And there was political incentive to make this trade. As it turns out any gains in lower unemployment bought this way proves to be temporary, while the associated inflation is not.

    While zoning rules have constricted housing supply, since 1980, lower mortgage rates have also been a contributing factor. While prices have grown faster than the general price level and wages, housing affordability has grown more modestly, as the monthly mortgage payment is a function of rates.

  9. Gravatar of dtoh dtoh
    9. August 2018 at 15:58

    I think it’s safe to say that inflation and recessions are almost always caused by bad monetary policy.

  10. Gravatar of ssumner ssumner
    9. August 2018 at 20:52

    Jerry, Going off gold (actually in 1968, not 1971) is part of monetary policy.

    Meets, So do I.

    Doug, Yes, that’s part of why they misjudged the situation.

  11. Gravatar of Benjamin Cole Benjamin Cole
    10. August 2018 at 02:49

    Turkey on the way to inflation. The central bank has been keeping rates low.

    Not sure how the neo-Fisher totem worshippers will play this one.

    The nation’s national budget deficit is just under 2% of GDP. It is running widening current-account trade deficits.

  12. Gravatar of Christian List Christian List
    10. August 2018 at 07:45

    Can someone explain why reducing housing subsidies would solve the problem? I don’t really get it. Isn’t the problem mainly supply-side?

    Let’s assume reducing housing subsidies reduces housing prices. And then what? More houses/apartments are getting built because people are willing to pay less? That doesn’t sound right.

  13. Gravatar of Michael Sandifer Michael Sandifer
    10. August 2018 at 07:55

    Christian List,

    Subsidizing demand will just raise prices further.

  14. Gravatar of Christian List Christian List
    10. August 2018 at 08:43

    Michael Sandifer,

    I get that part. What I don’t get is, how this would ease the situation, for example how falling prices would lead to more houses and/or apartments being built.

    As a non-professional it seems to me that supply-side restrictions are the problem.

    Sure those subsidies are nasty, unjust, and wasted but maybe for other reasons?

  15. Gravatar of Lewis Lewis
    10. August 2018 at 10:36

    I have to admit I have never understood Fischel’s hypothesis completely. It seems to be that, because homeowners have so much wealth tied up their houses, they oppose developments that could lower that wealth.

    The problem to me is that, if development does endanger property values, it makes sense for homeowners to oppose it regardless of how much of their wealth is tied up in homes…whether $100k or $500k, a loss of x% is still a loss. It’s not as though it’s very difficult to vote against liberalizing zoning.

    The real issue is that homeowners are allowed to have so much of a say about what kinds of housing people can build. This is what changed: the courts and ideology of our country changing such that people think it’s normal and even laudable to proscribe new homes.

    If we allowed musicians to decide what types of new music can come out, I’m sure there would be musicians who would show up at meetings all the time to oppose new music…sometimes for financial interest but very often simply out of some beliefs they have…or just to have an impact. I live in Berkeley and have been to several community meetings; it only takes about thirty insane people in birkenstocks with time on their hands to intimidate the public officials into proscribing housing. Fortunately, regarding music, the First Amendment proscribes how much governments can proscribe, so what we apparently need is a similar proscription on proscription for housing.

  16. Gravatar of Jeff Jeff
    10. August 2018 at 12:44

    the First Amendment proscribes how much governments can proscribe, so what we apparently need is a similar proscription on proscription for housing.
    The courts used to protect property and contract rights during what is now called “The Lochner Era” during the 40 years leading up to 1937. Except for some really bad monetary policy errors, the economy back then worked pretty well.

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