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Initial Conditions For Inflation: 1940s, 1970s & 2020s?

Mar 19, 2021

Executive Summary

  • A period of aggressive monetary and fiscal support has ushered in a consensus view of sustained inflation.
  • Today's initial conditions are far different from the start of the last two inflationary episodes in the 1940s and 1970s.
  • Inflationary pressure will emerge over the next couple of months, but transitory/cyclical inflation and sustained inflation are different.
  • Without a clean balance sheet, high real GDP growth, or a boom in demographics, sustained inflation will be much more difficult compared to the 1940s or 1970s.
  • The only way to sustain high inflation for multiple years or decades with low real GDP growth is to grant the Federal Reserve spending powers vs. lending powers or run sustained and larger budget deficits in perpetuity.

Initial Condtions For Inflation: 1940s, 1970s & 2020s? 

(To expand images, you can "right-click" and select "open link in new tab.")

The global pandemic of 2020 brought a swift and aggressive policy response from government entities which has ushered in a broad consensus of inflationary forecasts. 

To be clear, one year of rising or falling CPI is not the same as a sustained period of above-average inflation. 

In a recent note, The Money Supply Mystery, we discuss why we will undoubtedly see a sharp rise in consumer inflation on an annual basis due to supply chain damage, base effects, and a shift in consumer behavior. 

The case for lasting inflation, or consumer price growth that rises well above 2.0% for 5-10 years is much less clear, although the prevailing narrative would have you believe sustained inflation is a foregone conclusion. 

In this article, we will look at several initial conditions, including real GDP growth, population growth, savings rates, and more in the years leading up to and the years after the prior two major inflationary episodes of the 1940s and the 1970s. 

This article will highlight the stark differences in initial conditions today relative to the prior two periods of sustained inflation and why comparing the path forward today to the events of the 1940s and 1970s is not completely applicable. 

The inflation of the 1940s and the 1970s came with significantly higher real economic growth, a positive output gap relative to trend potential, lower levels of starting debt, positive net national savings, and radically different demographics. 

Inflation will appear in the coming months, but how long will it last? One or two quarters of 3% inflation is not the same as the inflation of the 1940s and 1970s, where inflation annualized more than 6% for 10 years straight. 

Sustained inflation in the 2020s will not come as easily as in the 1940s and 1970s. 

Differences In Initial Conditions

Over the past century, the United States has experienced two major episodes of above-average inflation, culminating in 1951 and 1982. The chart below graphs the 10-year annualized rate of consumer price inflation.

From 1941-1951, the US experienced sustained inflation of roughly 6%. A decade of 6% inflation. 

From 1972-1982, the US sustained inflation above 8%. A decade of 8% inflation. 

The last time the US had a ten-year period of 2% inflation was 2005-2015. 

US CPI: 10-Year Annualized Rate (%):

Source: Shiller, YCharts | To Expand, Right-Click > "Open Link In New Tab"

The extreme policy response to the COVID-19 pandemic has generated a massive consensus for sustained inflation similar to the 1940s or 1970s. It is important to note that these inflationary periods came with sustained inflation well into the mid-single digits for over ten years. 

A transitory or cyclical period of CPI inflation in the range of 3%-4% that lasts for a couple of quarters due to base effects and supply chain disruptions is entirely different from a decade of 8% inflation. 

In several charts below, we will look at the rate of real GDP growth, real GDP growth per capita, population growth, debt, and more leading up to and after the last two periods of high inflation. 

To start, US real GDP growth is on a completely different playing field than the 1940s or the 1970s. 

The chart below maps the 5-year annualized growth rate in real GDP back to the early 1930s. The 1940s came with sustained real GDP growth as high as 14%, while the 1960s and 1970s hardly saw real GDP growth below 3.0%. 

Real GDP growth has been on a major downward trend, seen clearly in the right-hand graph that starts in the 1950s to remove the axis-skew from the 1940s. 

The US has not sustained a period of 3.0% real GDP growth since 2007. 

US Real GDP Growth: 5-Year Annualized Rate (%)

Source: FRED, BEA | To Expand, Right-Click > "Open Link In New Tab"

The following charts show various initial conditions in the five years leading up to the inflationary period outlined and five years after the inflationary period outlined.

For example, the two most prominent periods of inflation, outlined in this article's first chart, are from 1941-1951 and 1972-1982. 

In the chart below, t+0 equals 1941, 1972, and 2021 given that most analysts believe we are at the start of another secular inflationary episode. Thus, the period t-5 through t+0 is the five years leading up to the start of the inflationary episode. 

The period t+0 through t+10 represents the bulk of the inflationary period, and t+10 through t+15 are the five years after the 10-year period ended. 

To reiterate, t+0, defined by the red line in the charts below, represents the conditions just before the inflationary decade started. 

Leading up to the 1940s inflationary episode, real GDP growth was increasing at over 7%.

Leading up to the 1970s inflation, real GDP growth was sustaining a rate north of 3.0%.

Today, we are starting a supposed decade of inflation with the lowest real GDP growth in modern history, increasing just over 1% per annum in the last five years. 

US Real GDP Growth: 5-Year Annualized Rate (%)

Source: FRED, BEA | To Expand, Right-Click > "Open Link In New Tab"

In per capita terms, one of the most important metrics for defining the standard of living, real growth was increasing above 6% before the inflation of the 1940s and rose to a sustained rate above 10% during the inflationary period. 

Real GDP growth per capita was steadily above 2.0% before and during the 1970s inflation and is starting this next decade at just 0.5%.

In other words, the inflation of the 1940s and the 1970s came with a major outward shift in demand in the form of explosive real GDP growth. 

Can we achieve the same level of consumer inflation without above-trend real GDP growth?

US Real GDP Per Capita Growth: 5-Year Annualized Rate (%)

Source: FRED | To Expand, Right-Click > "Open Link In New Tab"

Since the early days of the United States, real GDP growth in per capita terms annualized roughly 1.9%. When you take extremely long samples of real GDP growth normalized for population changes, real per capita growth always ends up near 1.9%, which we can define as the rough trend potential for society. 

So if we take the rate of real GDP growth per capita minus the 1.9% trend, we can see if the economy was growing above or below the long-term trend potential in per capita terms.

Leading up to the 1940s inflationary period, real GDP growth in per capita terms was more than 4% above the 1.9% trend. 

Leading up to the 1970s, growth was also above trend potential and almost never slipped below trend potential until the end of the inflationary period. 

Today, we are walking into a supposed decade of inflation after a decade of below-trend growth, building a deflationary gap as opposed to squeezing resources in above-trend growth.

US Real GDP Per Capita Growth: 5-Year Annualized Rate (%) vs. Trend (1.9%)

Source: FRED | To Expand, Right-Click > "Open Link In New Tab"

Demographics is the most important factor for determining long-run growth potential. Long-run growth is a function of population growth and productivity growth which we know, from the chart above, has limitations in the long-run around 1.9%. 

One way to sustain 4% real GDP growth is to have 2.0% population growth with just a trend productivity growth of roughly 2.0%. 

Often overlooked, starting in the 1940s, the US began the largest demographic boom in modern history, with population growth rising from 0.8% to start the inflationary decade to nearly 2.0% 15 years later. 

In the 1970s inflationary episode, population growth was starting above 1.0% and sustained a rate above 0.8% for the entire 20-year sample. 

Today, population growth is just 0.6% and expected to stay at 0.6% or move lower over the next decade. 

Thus we have another factor that is not working to generate inflation in the same fashion as the 1940s or 1970s; we do not have an outward shift in the demand curve coming from demographics.

Population Growth: 5-Year Annualized Rate (%)

 Source: FRED, Census Bureau | To Expand, Right-Click > "Open Link In New Tab" 

While data is more difficult to gather for the 1940s, the 1970s saw a major shift in the demand curve through a rapid increase in the employment to population ratio. 

The employment to population rate is roughly at the same level today as it was to start the 1970s inflation, but the path was sharply higher for the next 10 years while the expected path is lower today. 

Employment-Population Ratio:

Source: FRED | To Expand, Right-Click > "Open Link In New Tab"

The employment to population ratio has been declining sharply since the late 1990s. To assume we will have the same increase in the employment to population ratio would make the chart look similar to the estimate below in which the secular trend completely reverses. 

Demographic trends are strongly in favor of lower employment to population rather than higher like in the 1970s, at a time when heavy fiscal support is working to keep more people out of the labor force rather than in the labor force. 

Employment-Population Ratio:

Source: FRED | To Expand, Right-Click > "Open Link In New Tab"

While Federal debt to GDP rose above 100% during WWII, many analysts gloss over the fact that the major increase in spending started with a debt to GDP ratio of just 44.5%. Similarly, in the 1970s, debt to GDP started at around 35%. 

Today, Federal debt to GDP will begin the current spending spree at 130%. 

The law of diminishing marginal returns ensures that today's government spending will be less impactful at generating GDP growth compared to the 1940s and the 1970s. 

Federal Debt to GDP (%):

Source: FRED | To Expand, Right-Click > "Open Link In New Tab"

The McKinsey Global Institute helps us piece together data on debt to GDP during the depression and WWII period. It is worth noting that McKinsey highlights a "default" phase and a "belt-tightening" phase prior to the inflation of the 1940s, with neither phase experienced today. 

Around 1941, the starting period in our charts (t+0), total debt to GDP was below 180%. 

Total Debt To GDP (%):

Source: McKinsey Global Institute | To Expand, Right-Click > "Open Link In New Tab"

Domestic nonfinancial debt is nearing 300% today compared to less than 180% in the 1940s and less than 140% to start the inflationary period of the 1970s. 

Domestic Nonfinancial Debt to GDP (%):

Source: FRED | To Expand, Right-Click > "Open Link In New Tab"

The net national savings rate aggregates the government savings (or dissavings), personal savings, and corporate savings.

To start the 1940s inflationary episode, the net national savings rate was very high at 14.7% and sustained a positive rate above 5% for the entire sample period surrounding the inflationary decade. 

In other words, despite the government running large budget deficits, we were above to "cover" the deficit through savings in the personal and corporate sector. Government dissavings was offset by private savings out of earned income.

In the 1970s, net national savings started at 9.1%. 

Today, we are starting a major spending spree with negative net national savings. What does this mean? 

This means that we have an insufficiency of resources (land/labor/capital) to sustain private investment, which grows GDP in the long-run. We operate in an open economy, so we can obtain the necessary resources by running a larger trade deficit which hollows out US production jobs, lowering the labor force participation rate and the employment to population ratio from the charts above. 

Net National Savings Rate As A % of GNI:

Source: FRED | To Expand, Right-Click > "Open Link In New Tab"

In the 1940s, we covered the government spending with personal savings out of income. Today, the personal savings rate is rising but the personal savings is coming from government dissavings rather than earned income. As a result, we are not "covering" the government dissavings and the result is a negative savings rate for the country in aggregate, a stark difference to the 1940s and 1970s. 

So starting a massive spending plan with negative net national savings will cut against GDP growth. 

Either we sacrifice new private investment, or we run a larger trade deficit and sacrifice good, high-paying production jobs. 


The differences in initial economic conditions leading up to the 1940s and 1970s inflationary episodes are clearly visible today. In both the 1940s and the 1970s, a major outward shift in demand occurred through the demographic vector, which boosted real GDP growth well above the long-term trend potential, creating a squeeze on resources, leading to price pressure. 

In the 1940s, supply chain damage from the war also contributed to a large inflationary impulse. 

In both the 1940s and 1970s inflationary episodes, it is important to remember these periods of high inflation lasted for over ten years. Today, we will have one or two quarters of 3%+ inflation due to supply chains and base effects, but that elevated rate will hardly be sustained for a decade to come, given the initial conditions. 

CPI Inflation W/Base Effect Estimate:

Source: BLS, EPB Macro Research | To Expand, Right-Click > "Open Link In New Tab"

We should all prepare for cyclical inflationary pressure that emerged in the fall of 2020, but whenever an inflationary narrative comes to the table, we should ask ourselves how will this be sustained for five years or for ten years?

The debt overhang and the trend of worsening demographics as opposed to booming demographics will make it difficult or impossible to sustain lasting inflation through an outward shift in demand or real GDP growth like in the 1940s. 

In the recent article, The Money Supply Mystery, we cover why increased money supply isn't leading to higher inflation but rather higher asset prices. 

The easiest way to create sustained inflation would be to grant the Federal Reserve spending powers as opposed to lending powers. 

Federal spending will not create lasting inflation unless the spending is perpetual and ever-increasing in terms of a share of GDP, as diminishing marginal returns will render each spending program less impactful. Moreover, the spending stopped in the 1940s and 1970s, but the inflation was lasting due to an outward shift in demand. 

If the Federal spending stopped today, the disinflationary pressure would return almost instantly. 

There is cyclical inflation pressure and secular inflation pressure. Cyclical inflation pressure is present and ongoing for the next several months (at least). Secular inflation pressure is not present given the initial conditions, baring a radical change in the Federal Reserve's operations or a perpetual spending program with built-in increases so that government spending as a % of GDP rises indefinitely until reaching 100% or bankruptcy. 


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