Vague ramblings

Inflated expectations: the Phillips Curve ball

Posted in Business, Musing by Ian Cundell on 27 September, 2013

We are very good at ignoring information that conflicts with our world view. Call it over-confidence in your current forecast, call it confirmation bias, call it Albert. The phenomenon is well known.

In my last blog I described how a multi-generational experience of inflation – but especially the cancerous inflation of the 1970s – has shaped perception on what is and isn’t a safe investment for ordinary people. Since then I carried on prodding and poking the numbers and found something interesting, especially when combined with some other tidbits.

Investment performance since 1979 (nominal)

Investment performance since 1979 (nominal)

Look at these two graphs.

The first one shows the nominal performance of three investment options since 1979 (again, a bit arbitrary but coinciding with the start of Thatcherism – read nothing in particular into this, it just seemed reasonable).

The second shows the same thing but with inflation removed (so investment performance against it is not included).

Look at them.

There is no getting away from it it, is there?

Investment performance since 1979 (real)

Investment performance since 1979 (real)

They are as near-as-dammit, identical. Savings: “Meh”; property: better than “Meh”; shares: even better than “Meh”, but wildly erratic.

The 1970s saw the economy holed below the waterline; it would have been all but impossible for the overall trajectory to have been anything other than upwards and a perfectly reasonable case can be made that it should have been steeper.

But that is not the issue here.

Keith Joseph screwed down the money supply and although Nigel Lawson let rip a potential tidal wave of inflation in 1987 (with inevitable consequences in 1990), eventually Ken Clarke turned up and put the Exchequer back in the hands of the grown-ups.

Gordon Brown followed in Clarke’s footsteps, at first, but then seemed to forget his own golden rules (although I doubt there is much he could have done about it anyway – a debate for another day).

Because, again, that’s not really the issue here.

discourse is still, by-and-large, created by those with outlook shaped by the 1970s.

The generation born since the mid-1970s, despite a blip caused by Nigel Lawson’s stupidity, have no idea what real inflation is – with one exception. Look how steeply the house price line climbs after about 2001 (after people got put off stocks and shares by the dotcom crash and egged on by the arrival of ludicrously easy credit). Look at that 1990 crash in housing. It is epic, but has been all but airbrushed out of discourse – because that discourse is still, by-and-large, created by those with outlook shaped by the 1970s. There is out of date thinking going on here. Inflationary expectations are still in the mix and Gordon Brown did nothing to change this.

Here’s the thing:

  • Just suppose that Thatcher’s generation can be disabused of the idea that housing is an easy way to rack up some value, with easy trading up;
  • Just suppose that the generation that is set to retire in 10 years or so realise that they aren’t going to have worthwhile pensions;
  • Just suppose that neither the Coalition nor a potential Labour government will have the bottle to loosen the fiscal strings.

A lot of things could happen:

  • the retired could take their released equity and bugger off somewhere sunny;
  • the young could be forced back to the notion that homes are for nesting, not investing (sorry, cliché alert);
  • the economy could continue to be less that stellar.

All combined, these could squeeze inflationary expectations out of the system. Economics used to be governed by the Phillips Curve (unemployment up > inflation down/ unemployment down > inflation up). The 1970s put paid to that and various other curves building in inflationary expectations came along. But now what?

There are no formulas here, no “rational expectations”, and certainly no certainty.

Without strong unions to bid up real wages; without the certainty of growth or the security of pensions; without fiscal stimulus then Philips might just make a comeback.

And real house prices could fall, consistently, for the first time in three generations.

(The views expressed here are not in any way advice and are subject to change in the face of new evidence)

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