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OTTAWA — During the 1970s battle against stagflation, when two major oil shocks triggered rising unemployment and inflation, the federal government took it upon itself to stifle the vicious wage-price spiral.
Ottawa set up the Anti-Inflation Board, and when that didn't quite work, the government launched the so-called 6-and-5 program, aiming to restrain both prices and public sector wages.
“The government wanted to … tighten the screw on inflation a bit tighter,” says Toronto-Dominion Bank chief economist Don Drummond, who started his career at the federal Finance Department in 1977, assessing the inner workings of the 6-and-5 program.
The era of 1970s stagflation, with its lineups for gas, pink slips, strikes, rising mortgage rates and political tensions, remains a painful memory for many Canadians.
In recent months, that memory has haunted policy makers, as a fresh oil shock has slowed growth while sending prices higher around the globe.
Bank of Canada Governor Mark Carney raised the spectre of the 1970s as the main reason for his sudden change in direction in June, which put an abrupt end to stimulative rate cuts.
Gordon Brown, the Prime Minister of Britain, and Jean-Claude Trichet, president of the European Central Bank, have expressed similar fears about stagflation. When the U.S. Federal Reserve meets Tuesday, inflation is expected to weigh heavily in central bankers' discussions.
But despite the parallels, a 70s replay is unlikely, many economists say. That's in large part because the role of policy makers – both fiscal and monetary – has changed radically.
In Canada, the Anti-Inflation Board has long been abolished, and inflation and growth are largely left to the central bank. The bank, like its counterparts around the world, has adopted a much more effective approach to targeting inflation now, too.
Instead of targeting the money supply – de rigueur in the 1970s – they target inflation itself, and use interest rates to fine-tune market conditions. In most developed countries, including Canada, central bankers have managed to keep inflation expectations and inflation itself largely in check over the past decade.
“The 70s are inviting because we look like we're going to see stagflation again,” said Duncan McDowell, a professor of economic history at Carleton University in Ottawa. “But I think in many ways, it's such a different era that it's not a very useful parallel.”
There's no doubt the similarities are numerous. Like now, Canada in the 1970s was struggling with soaring oil prices. Consumers began cutting back on their gasoline consumption, turned down their heat, and sought alternatives.
A prosperous West faced off against a pummelled Central Canada; regional tensions were aggravated; manufacturing was under stress; growth slowed; unemployment crept up. And in 1979, we even had a minority Conservative government supported mainly by the oil-rich West, under pressure from the rest of the country to better spread the wealth.
“People don't forget that. It was a real culture shock, and people don't want to go there again, in terms of their mortgage and unemployment, and regional tensions,” Prof. McDowell said.
And it's possible to create a plausible scenario in which the stagflation of the 70s – along with the subsequent deep recession of the early 1980s – could make a repeat appearance. CIBC World Markets chief economist Jeff Rubin argued such a case last week, forecasting the return of a wage-price spiral, sky-high gasoline prices, 6-per-cent inflation in the United States, and a sharp series of interest rate hikes by the Fed.
But the similarities aren't enough to make the spectre of 70s- and 80s-style stagflation a lesson guide for how not to handle today's dynamics, most analysts say.
The Canadian economy in the 1970s was dominated by heavy-handed government decisions. In addition to the price and wage controls, Ottawa paid for huge infrastructure projects, and had no qualms about running up large deficits to stimulate the economy.
From the late 1950s until 1973, the Canadian economy improved its productivity by 2.5 or 3 per cent a year, Mr. Drummond notes. Governments assumed that productivity would continue to surge, and spending could rise accordingly. But productivity slowed, and deficits became chronic, eventually circumscribing the government's flexibility.
Central banks made similar mistakes. The Bank of Canada targeted the money supply in order to keep a poorly defined control on inflation, Mr. Drummond recalls. It later became obvious money supply was the wrong thing to target because it was hard to measure, and didn't relate closely enough with inflationary pressure to be of much use. “We were largely rudderless,” Mr. Drummond said.
Today, the central bank is clearly mandated to keep inflation near the 2-per-cent rate, governments are running balanced budgets, and even if Ottawa slips into deficit early next year, it will be small and temporary, economists say.
Plus, Canada's economic fortunes are not as closely aligned with the U.S., in these days of free trade and globalization, as they were in the 70s, when trade was heavily managed, Prof. McDowell says.
Now, the underlying assumption is that supply and demand will best find an equilibrium on their own accord. If governments are looked to for answers, they are expected only to tinker: Raise or lower interest rates, fiddle with tax incentives, encourage energy conservation.
The differences between now and then extend well beyond government attitudes. Oil and gas don't play as much of a role in household and company budgets now as in the 1970s, so a shock in the oil price is not as much of a shock to the pocketbook as three decades ago, economists say.
As a result, workers are far less likely to demand pay hikes to face their rising energy costs, and have less power to demand such raises due to global competition.
Recent research shows that even though the price of oil has skyrocketed, the effect on inflation and growth has been mild, not just in Canada but across industrialized countries.
U.S. economists Olivier Blanchard from MIT, and Jordi Gali from the National Bureau of Economic Research, conclude oil shocks just aren't as shocking now as they were in the 1970s because labour markets are more flexible, oil is used less in production, monetary policy has improved and the world economy has had a stroke of “good luck.”
The luck comes in, they say, because the 1970s oil shocks coincided with other adverse shocks.
“The U.S. economy is not doing great, but the main source of trouble is housing and financial,” Mr. Blanchard wrote in an e-mail. “By itself, the increase in the price of oil, while clearly bad news, will not lead to a replay of the 1970s.”
“Based on our estimates, it should lead to slightly lower growth and slightly higher inflation for a year or two.”
