Scot Sumner has a clever and quite possible correct explanation for how a large real negative shock – an increase in the price of petroleum in 1973 – causes a recession. He agrees with Tyler Cowen and Alex Tabarrok that the shock itself was large enough to reduce the productive capacity of the economy to cause a recession-size fall in real income.
Sumner speculates that the Fed say the spike in the domestic prices of fossil fuel products and mistakenly tried to offset the supposedly inflationary effects of this “supply chain disruption’ (my words) by actually tightening monetary policy, using whatever instruments it had to reduce inflation. This is of course the opposite of what a central bank should do (and the Fed in fact did when faced with the double shock of Covid business closures and the petroleum price effects of Putin’s invasion of Ukraine): increase inflation to facilitate relative price changes and re-allocation of production and consumer demand. This temporarily higher inflation is what is meant by the Fed’s _Flexible_ Average Inflation Targeting; inflation is adjusted up and down to sustain maximum real income growth.
[See the discussion at:
https://substack.com/home/post/p-145235739?source=queue.]
In the case of the US, the negative supply shock was exacerbated by price controls that slowed adjustment to the higher prices of petroleum products resulting in gas lines and knock-on disruptions at firms that could not get needed petroleum products.
Sumner contrasts US price controls in the early 70’s with the German adjustment in 2021-22 to Putin’s cut-off of natural gas imports when as Tabarrok says, “A lot of people, including German politicians, predicted that Germany would have to ration gas, that people would freeze to death, that the economy would go into a deep recession.” Fortunately, “In the end, the German economy adapted to a much lower supply of natural gas by using less and finding substitutes.[1] The spot price of gas rose by a factor of more than eight at peak, but instead of price controls and rationing, the German government let the price rise, but they did protect German consumers with a lump sum transfer based upon the past use of natural gas.” Moreover, as Sumner observes, “Why were the pessimistic forecasts wrong? Why did Germany experience such a small rise in unemployment? Monetary policy in the Eurozone remained expansionary….” The ECB did NOT try to reduce inflation.
Image prompt: A (stereotypically German) holding a high voltage, sparking electric line with complete equanimity.
[Standard bleg: Although my style is know-it-all-ism, I do sometime entertain the thought that, here and there, I might be mistaken on some minor detail. I would welcome comments on these views.]
[1] This is not to minimize the real economic and environmental damage that Putin inflicted, damage that was made worse by the vulnerability from having closed nuclear power generation facilities.
The transaction's velocity of money surged during this period. But you had to splice the G.6 release during this period because of a redistribution in SMAs
During the decade before 1965 the annual compounded rate of increase in our means-of-payment money supply was about 2 per cent. During the same period, the annual transactions velocity of money increased from c. 21 to 31. In ten in-year period since 1964, the money stock grew at an annual compounded rate of c. 6.5 percent and the transactions velocity of money reached an average level of 70 in 1973.
Velocity continued to increase to over 80 during 1974. Both money and velocity figures were taken directly from the Federal Reserve Bulletin. The impact of both an accelerated increase in the volume and velocity of money on prices is made even more evident if the rate of increase in aggregate monetary demand (money time’s velocity) is examined.
During the decade ending in 1964, money flows increased at an annual compounded rate of about 6 percent. In the nine years since 1964, the increase was more than 13 per cent, and in 1972-73, nearly 30 percent. Because R-gDp and presumably, the volume of goods and services offered in the markets, was increasing at a rate of less than 5 per cent, it should have been no surprise that there was an intensification of our chronic rates of inflation to devastating levels.