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Inflation is high, but context differs from the 1970s


Published: 28 July 2022

Man met steekkar vanaf boven

The current high inflation in the Netherlands occurs in a different economic environment than in the 1970s. Back then, the labour market, the financial position of businesses and monetary policy were a breeding ground for stagflation.

Negative supply shock, like then

In the 1970s, as today, the Dutch economy had to grapple with soaring oil and food prices. This pushed up inflation and, in time, resulted in economic contraction in the early 1980s. The combination of high inflation and negative growth is referred to as stagflation (see Figure). Stagflation can generally be caused by an unexpected decline in the availability of inputs, such as construction materials or energy. This reduces the supply of goods and services, which, even with constant demand, leads to price increases across the board.

At the moment, the Dutch economy is also struggling with high inflation following a negative supply shock. Disruptions in supply chains and the consequences of the Russian invasion of Ukraine have made raw materials and semi-finished products scarcer and more expensive. This is hampering businesses’ output, which, as in the 1970s and 1980s, brings downward risks to economic growth. However, the current situation is not expected to usher in a similar period of stagflation (see the projections for 2023 and 2024 in the figure). Even though scenarios are conceivable for growth to turn negative in 2023 and underlying in 2022 (see Economic Developments and Outlook, June 2022), the combination of negative growth and high inflation would still differ from the conditions prevailing in the 1970s and 1980s.

Differences from stagflation period

At the time, wages rose automatically in line with inflation. Such index-linking of wages and benefits, which applied in the Netherlands until 1982, stimulated a wage-price spiral. The wage rate per employee rose considerably faster than labour productivity, thereby eroding the competitiveness and profits of businesses. Business investment consequently slackened off. During the subsequent deep recession, unemployment in the Netherlands rose to more than 10% of the labour force in the early 1980s.

Today, nominal wages are generally no longer automatically linked to inflation. Although the current tightness in the labour market is contributing to wage growth, estimated average wage increases this year are even below inflation. As a result, real wages on average are falling this year across the entire Dutch economy (see our projection in the Economic Developments and Outlook, June 2022).

Furthermore, Dutch businesses are in much better shape now than they were then. In 2020-21, the profit ratio of all non-financial corporations averaged 40%, against 34% between 1972 and 1982. This means businesses generally now have more headroom to absorb temporarily higher wage costs.

Furthermore, economic and monetary policies are different nowadays. Monetary policy today focuses on price stability and aims to keep inflation expected by households and businesses close to the target figure. At the time, policymakers generally pursued an accommodative monetary policy, the assumption being that this would have positive long-term effects on employment. However, this policy also fuelled inflation. In the first half of the 1970s, high inflation was accompanied by relatively buoyant growth (see figure), a combination that ultimately proved unsustainable.

High inflation ultimately damages growth

In the longer run, economic growth cannot be boosted or unemployment lowered by allowing inflation to rise. In fact, a recent study by DNB researchers shows that excessive inflation harms an economy’s growth potential. As such, tightening monetary policy with a view to safeguarding price stability ultimately supports the economy and employment. This reduces the risk of a new period of stagflation.

Stagflation, high inflation in the 1970s compared to the year 2022

Notes: Stagflation is defined as a year in which annual real GDP per capita growth is 0% or lower while inflation exceeds the average rate plus 1 standard deviation (representing an inflation rate of 5.8% or higher, measured over the 1970-2021 period, annual figures). Inflation is CPI in 1970-1996 and HICP from 1997. Inflation and GDP per capita growth in 2022-2024 are the projections in our Economic Developments and Outlook, June 2022.

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