Approximately two-thirds of the inflation was A Year of Surprises In retrospect 1973 was a most unusual year in economic terms. As everyone now knows, the year saw rapid inflation unmatched since the end of World War I, except for the period immediatelv after World War II (1946-48) and the outbreak of the Korean Wholesale prices were 20.8 percent higher in War (1950-51). Price Index increased 9.4 percent in the same period. (The WPI increase for the average of 1973 over the average of 1972 was 13.8 percent and the average CPI increase was 6.2 percent.) These price increases were the more disturbing since they were largely unforeseen and unexpected by all analysts regardless of economic or political persuasion. Both government and private forecasters were projecting 1973 inflation in the GNP deflator of about 3 percent.1/ None of the fore casters came close to anticipating what actually happened. The GNP deflator actually increased 5.3 percent. Appendix A, Pg A-1 shows the 1973 forecasts of a large The year has raised the most serious questions as to the adequacy of economic data and methods of analysis and forecasting particularly with respect to prices. As the incoming President of the American Economic Association, Professor of re-examination. The energy crisis caught us with our the limitations of For me the year has reinforced aggregate economic tools and has emphasized the validity of the view that detailed data and analysis of separate sectors and markets are essential to understanding and forecasting, and even more vital to economic policy making, certainly in the peculiar economic environment of 1973-74. The forecasts of food prices are illustrative of the extent to which price increases were unexpected. For example, on February 13, 1973 the Department of Agriculture stated that retail food prices for 1973 would average around 6 percent above 1972, and on May 8 it stated that "prices may average 9 percent above 1972." The actual year over year increase in retail food prices, including food at home and food away from home, was 14.5 percent. The January, 1974 figure was 27 Quoted in Washington Post, January 3, 1974, p. A-24. 19.5 percent over January, 1973. The record of most other farm price forecasters was no better. During the year, the Cost of Living Council strongly urged that we examine critically this shortfall in prediction to see what could be learned as to technical methods and administrative arrangements to improve the quality of agricultural forecasting in the future. A careful review has been made and a number of measures already have been taken including bringing other agencies into the quarterly outlook review sessions, improving the methods of estimating livestock numbers and an overall review of forecasting techniques. The most important single source of the underestimation in 1973 was the failure adequately to relate the United States economy to the world economy, particularly when large agricultural stockpiles no longer served as a buffer. It must be recognized, however, that some uncertainties in food price forecasting will always remain as a result of weather, disease and the like. International Commodity Inflation After the first quarter of 1973 it became reasonably clear that the entire Western world was facing a major inflation in primary product prices. This development was related to the very high levels of output in Japan, Western Europe and the United States in 1973. The rapid rate of increase in output was itself an independent factor creating 30-463 - 74 - 4 6 inflationary repercussions since there was less time to adjust to high output levels. Special factors, including weather, reduced the output and the stock of agricultural commodities. The devaluation of the dollar and its further decline in international markets in the early months of the year accelerated the dollar price inflation in primary commodities. The Economist index of world commodity prices in dollars increased 46.2 percent for all items in the year ending January 2, 1974. Food prices rose 38.6 percent, fibers 21.3 percent and metals 86.7 percent in the same period. 3/ In the United States, food and energy prices alone accounted for 67.2 percent of the increase in the WPI and 61.3 percent of the increase in the CPI between January, 1973 and January, 1974. The WPI for the United States for Fuels and Related Products and Power rose 71.4 percent in the period January, 1973 to January, 1974. With a weight of 7.1 percent in the WPI these prices contributed 26.0 percent to the change in the WPI, or more than three times their normal share. 4/ 3. 4. Appendix B, Pg. A-2 contains a series of graphs which Appendix C, Pg. A-14 shows the relative contributions of 7 It should be noted, however, that the worldwide inflation in primary products was associated in 1973 with a lesser rate of inflation in consumer prices in the United States than in most other advanced industrial countries. The petroleum crisis may be expected to have an even greater relative effect in other countries. The following chart reflects changes in the CPI in the past year for various |