My high school economics teacher used to defuse arguments with the saying “in the long run we are all dead”. He was quoting from John Maynard Keynes’ “A Tract on Monetary Reform”, which observed that the simplistic outlook held by Economists about an often uncertain world was about as helpful as the ancient Persian proverb “this too shall pass”.
Recently I’ve encountered numerous occasions where somebody said the current state of affairs is not “normal”, and that over the longer term we should expect them to “revert to the mean”. They could have been talking about anything from interest rates, inflation, property prices, to cryptocurrencies.
What they really mean is they endorse Isaac Newton’s observation “what goes up must come down”… and they believe the inverse is also true.
“what goes up must come down”
For mine, “normal” is a subjective term that is very much defined by perspective and outlook of the observer. Usain Bolt and Stephen Hawking probably consider themselves to be normal (we all do)… they just find the rest of us wanting!
I decided to dig into the numbers, to figure out for myself whether there was anything to this talk of returning to “normal”, or if it was just a load of bollocks.
758 years of inflation rates
First I looked at the annual inflation rates. Via the National Archives and the House of Parliament library, I found a research paper from the 1950s that tracked the annual price and wage inflation rates since the 1260s. I then extended the time series to today using figures from the Office of National Statistics.
There were some interesting results from analysing 758 years worth of data.
- The average annual inflation rate was 1.53%.
- The ride required to achieve that average was far from smooth, with annual swings of ±60%!
- Deflation occurred in 44% of the periods.
- Periods of 1970s style high inflation rates are not uncommon, though occur less frequently than they once did.
- The recent extended period without much inflation rate volatility is unprecedented.
Conclusion: The often repeated 2% annual inflation rule of thumb holds true.
324 years of interest rates
Second I looked at official interest rates. The Bank of England once published data going back to 1694. While the original download is no longer available, the Guardian has republished a copy which I have extended using current Bank of England figures.
324 years of interest rate data told an interesting story.
- The average interest rate was 4.71%.
- Only 16% of the historical periods have experienced interest rates exceeding 5%.
- The recent period of extremely low-interest rates is unprecedented.
- The high-interest rates experienced during the 1970s and 1980s were also an anomaly.
Conclusion: The historical average interest rate is approximately 10x those experienced today. Ensure you stress test your debt servicing plans appropriately.
758 years of wage growth rates
Finally, I looked at annual wage growth rates. The research paper mentioned above had attempted to collate a time series looking at the weekly wages received by a “building craftsman”. I extended the series using Office of National Statistics annual wage growth figures, which resulted in the substitution of the average worker for a “building craftsman” from 1955 onwards.
The 758 years worth of data tells a story, though one that should be treated with caution as the time series contained several gaps, some of which were lengthy.
- The average annual wage growth rate was 1.5%.
- Historically wages do down as well as up, with declines in wages reported in 33% of periods.
- Supply and demand play a huge role in setting wages. The effects of war, plague and famine plain to see.
- The absence of annual wage declines since the 1950s is inconsistent with the preceding 700 years experience. This is most likely caused by the substation of average wages for those received in a specific vocation, rather than a structural change to the way the economy works!
Conclusion: Short-term wage growth is determined by supply and demand for skills, however over the long term it unsurprisingly parallels inflation.
In the long run?
In the long run both Newton and Keynes were right. With the benefit of distance and hindsight, all the daily volatility and noise smooths out into a nice understandable trend. The historical data examined here shows that when viewed in a 750 year context, the last 25 years have been an economic purple patch.