Agreeing in different languages
Scott Sumner replies to my claim that the Great Inflation of the 1970s wasn’t a monetary phenomenon by saying, yes, in fact it was.
But reading his post, I don’t see any substantive inconsistency between his views and mine at all. He argues that the Fed overstimulated, because if it was trying to prevent unemployment, it would simply have stabilized nominal wage growth. Instead it tolerated — or caused, depending how you tell the story — wage inflation in excess of its long-term growth rate. My view is that stable nominal wages and full employment (under the Fed’s more robust 1970s definition of full employment) were simply inconsistent, so stabilizing nominal wages would not have been an effective strategy. Decent employment of a labor force growing faster than productive employment was only possible via a combination of falling real wages and a cross-subsidy from creditors, that is by high inflation.
I think Sumner says basically what I’m saying, when he describes stories of the Great Inflation he considers reasonable:
There are some theories that help us to understand why the Fed blew it in the 1966-81 period:
Assumption of stable Phillips Curve.
Mis-estimation of the natural rate of U, which was rising.
Confusion between nominal and real interest rates.
Waldman’s theory deserves to be added to that list. It’s not the whole story, but it’s a significant piece of the story.
In the language that Sumner (like many economists) uses, the “natural rate of unemployment” was rising. In that language, my claim is simply an explanation of why this rate was rising: Growth of the workforce was temporarily outstripping the economy’s capacity to employ marginal workers at expected levels of productivity. It sounds like Sumner considers this to be at least a reasonable conjecture.
The Great Moderation consensus was that unemployment should be reduced to this “natural” or “non-accelerating inflation rate of unemployment“, but no lower. But that reflects a value judgment about the relative pain of inflation versus unemployment, a judgment that central bankers of the 1970s simply did not share. To say that policymakers erred or even misestimated, you’d have to claim they did not understand that their employment-focused policies might bring inflation. I think it’s pretty clear that they did understand that. They simply made a choice that became taboo during a later period. They accepted a risk of accelerating inflation in pursuit of full employment.
So was the Great Inflation a “monetary phenomenon”? It really depends on how you assign causality. Suppose that I am right, that largely for demographic reasons, the “natural rate” of unemployment was higher than the socially acceptable rate of unemployment. Central bankers deliberately tolerated a risk — unfortunately realized — that inflation would become a significant problem. Does that mean the inflation was a monetary phenomenon? In a sense, yes, in a sense, no. The inflation could have been avoided with different monetary policy at cost of accepting a painfully high “natural” rate of unemployment. In that sense, it was monetary.
But the deeper cause, the factor that created the conditions under which the central bank was faced with so terrible a choice, was a real mismatch between the growth rate of the work force and the speed with which organizations and machines could be arranged to make all that labor productive.
Let’s try an analogy. Consider the hair loss of a cancer patient. Doctors make a choice, weighing the harms of chemotherapy with the risks of nontreatment. When doctors choose to apply chemotherapy, they “cause” the loss of hair and other toxic side effects of chemotherapy. The choice to treat or not to treat may sometimes be a close call, so doctors and patients never really know whether the putative reduction of cancer risks was worth the certain pain of chemo.
Nevertheless, we don’t often describe all that hair loss and pain as “iatrogenic illness“, even though strictly speaking it is. To do so, we recognize, would be to place blame where it doesn’t belong, on the people making very difficult choices in response to circumstances they did not create. We rage about iatrogenic illness when people are hurt because doctors fail to wash their hands or follow checklists. But during chemo, we acknowledge the cancer as the true cause of the bad situation, and don’t blame the doctors.
Similarly, if the real-economic situation was as I contend in the 1970s, it strikes me as churlish to refer to the inflation as a “monetary phenomenon”. Yes, different monetary choices might have led to less inflation. But they would have risked much higher levels of unemployment. No, we never will know how that counterfactual would have worked out. But I consider the absorption into the labor force of the baby boom, of both sexes of the baby boom, to be a remarkable achievement. Considering the social and political circumstances in the late 1960s and early 1970s, I don’t think it’s at all obvious that we’d have been better off choosing a different balance of risks.
Sumner points to the assumption of stable Phillips Curve as a potential explanation of the Great Inflation. There might have been some economists who believed in a stable Phillips Curve, but I think that is mostly a straw man. It’s hard to find examples of influential people actually making this mistake. The Phillips Curve certainly did shift into the 1970s, but I’d argue it did so precisely due to the demographic / real-economic problem the United States faced during that era rather than due to the Lucas Critique explanation that näive reliance on the relationship undermined it. I think there was no näive reliance at all, just difficult choices made by policymakers fully cognizant of the uncertainties they faced. I perceive a lot more overconfidence and dogmatism in post-1980s reaction to the Great Inflation than there was in the choices that preceded it.
Ultimately, hubris is the issue. I am writing in 2013 about choices made in 1973 because I think a mythology has developed around 1970s experience that is very harmful. Whether he agrees or disagrees with anything I’ve said here, Scott Sumner is much more ally than adversary. He as much as anyone has challenged the new orthodoxy symbolized by “divine coincidence”, a property woven into some New Keynesian models to sanctify the claim that there are no trade-offs in macroeconomic policymaking. Stabilizing inflation is always enough in these models, because stabilization of output necessarily follows. That is a terrible error. Arthur Burns was pushed around by Richard Nixon and knowingly made difficult trade-offs. Jean Claude Trichet was pushed around by no one, and stabilized inflation “impeccably“. In doing so, Trichet made errors that have already been far more costly than the American experience of the 1970s, mistakes whose costs have yet to be fully tallied.
The real economy always gets a vote. The political economy always gets a vote. This isn’t some kind of econopartisan divide. There are post-Keynesians who claim that the combination of good fiscal policy and a job guarantee can always deliver price stability and full employment. But no policy rule can guarantee those things. If real output collapses, or if the population grows in ways that cannot be technologically matched to production of the goods and services it wishes to consume, meaningful full employment will imply inflation or else more direct transfers. First-best policy would be to prevent real- and political-economic cul de sacs. Unfortunately, we’ve already failed to prevent some political-economic disasters: the institutional configuration of Europe, rent extraction and socioeconomic segregation in the United States. Because they were not prevented, we face real tradeoffs, between those who might be harmed by inflation and those at greatest risk of unemployment, and along all kinds of other dimensions. Polities will have to make these tradeoffs, or find creative means of rearranging themselves to circumvent the fighting. Absurdly abstract cautionary tales flogged as “science” by representatives of a class of people whose interests are enmeshed in the tradeoffs are much worse than suspect.
The previous post, like nearly all my posts, generated a comment thread with thinking and writing much better than my own. (Read it!) I continue to believe that demographics plus real-economic rigidity created conditions that rendered the 1970s inflation better than many alternatives. I don’t claim that always and everywhere population booms must coincide with productivity collapses — sometimes population booms coincide (usually not coincidentally!) with opportunities for expanded production. I don’t claim that all monetary expansions derive from attempts to employ a burgeoning population. (Sometimes they are about exchange rates, for example!) History is not an ergodic process. If the evidence for my conjecture seems unrigorous, I’d ask you to compare it to the widely accepted view all we needed was Paul Volcker a decade earlier and things would have been just fine. Where is there evidence for that?
Update: Scott Sumner responds.
Update History:
- 7-Sept-2013, 12:15 p.m. PDT: Added bold update, link to Scott Sumner’s response.
- 7-Sept-2013, 12:40 p.m. PDT:Inserted the word “monetary”, “Yes, different monetary choices…”
Perhaps it’s just coincidence, but do stagnant real wages since the 1970s have anything to do with opening the labor market for a larger number of new workers in the 1970s?
September 7th, 2013 at 3:57 am PDT
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“So was the Great Inflation a “monetary phenomenon”?”
Yes but on purpose. Either have inflation high or UE high. The policymakers chose higher inflation.
No other way to get around sticky wage prices. Markets were force to clear at a higher nominal level. Otherwise you could of eventually had the same level of UE at a lower price in the longer term, but the short term would of been harder.
September 7th, 2013 at 5:03 am PDT
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Very nice post… and deftly exploring the inner sanctum of monetarist vocabulary.
“So was the Great Inflation a “monetary phenomenon”? It really depends on how you assign causality… The real economy always gets a vote.”
It might be interesting to see how the following people define “monetary phenomenon”:
a) Friedman
b) Sumner
c) Waldman
More than pedantic, it may help frame arguments. It always seemed to me that you could drive a Mack Truck through Friedman’s iconic monetary phenomenon statement. It appears to me as if it means little, because it means anything and everything. But maybe that’s because I don’t know what the definition of “monetary phenomenon” is supposed to be.
The carefully crafted definition can ensure that inflation is always a monetary phenomenon, and that the 1970’s qualify along with every other episode. E.g. merely invoking a counterfactual monetary policy can give rise to the claim – “there, I told you so, it was a monetary phenomenon” – or something like that.
As Sumner says “he is actually arguing that it was a monetary phenomenon.”
It seems that in this case you and Sumner probably don’t disagree on a whole lot other than the (implied) framing for “monetary phenomenon”.
So three things – what’s that definition, what is the point being made in the context of that definition, and is that definition binding on that point?
Oh, the vocabulary of it all…
September 7th, 2013 at 7:35 am PDT
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To say that policymakers erred or even misestimated, you’d have to claim they did not understand that their employment-focused policies might bring inflation. I think it’s pretty clear that they did understand that. They simply made a choice that became taboo during a later period. They accepted a risk of accelerating inflation in pursuit of full employment.
I notice that the charts in your previous post are of the Civilian Labor Force. Are any available for the Non-Civilian Labor Force? Both the draft and Vietnam war ended during the 70s shifting a lot of young people with military training from the non- to civilian labor demographic. It would have been extremely foolish of policymakers not to try to ease the shift in some way. Something more direct than monetary expansion would have been better but not really doable in such tense times.
September 7th, 2013 at 9:10 am PDT
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Fascinating posts! I also think another concern in the 70s that contributed to institutions deciding (consciously or unconsciously) to err on the side of higher inflation rather than higher unemployment was crime. When people are younger they tend to commit more crimes and there was indeed a LOT more of that back then. I certainly would want to get employment as high as possible – can you imagine how dreadful the crime rates would have been if we would have tried to squelch out the inflation of that time? Perhaps we staved off a revolution…
September 7th, 2013 at 9:21 am PDT
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Steve, thanks for this. I’ve been worrying at the 70s-inflation explanations for a decade, and while most seemed to have some merit, try as I might to give them the benefit of the doubt, they’ve never cohered for me into a coherent and convincing story. Even putting aside the sometimes problematic economic logic, the causes being described just never seemed big enough to bring about the massive effects. The labor force growth depicted in your graph very much does.
So this is an aha post for me and I hope for others. Of course the rapid rise in the labor force that you point out was a huge factor driving The Great Inflation (including the Fed’s reaction), a factor that has been completely ignored in the mainstream explanations I’ve read.
For just one example, this October 2012 FRBSL classroom primer on The Great Inflation, encapsulating the mainstream view.
http://research.stlouisfed.org/pageone-economics/uploads/newsletter/2012/PageOneClassrmEdition1012_GreatInflation.pdf
No mention of labor force.
Bravo. I finally have a coherent and satisfying explanation of that phenomenon — whether you want to call it monetary or not. Or at least you’ve added a crucial missing piece. Thanks.
September 7th, 2013 at 10:24 am PDT
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Steve will you fix my ital error after “of course” in the above? Thx. [Done! —SRW]
September 7th, 2013 at 10:26 am PDT
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So is this a real business cycle theory of 70s inflation?
September 7th, 2013 at 11:20 am PDT
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[…] Randy Waldman delivers another Aha! post (and a followup reply to Scott Sumner) pointing out a huge driver of the 1970s Great Inflation — the rise in the […]
September 7th, 2013 at 11:42 am PDT
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[…] Randy Waldman delivers another Aha! post (and a followup reply to Scott Sumner) pointing out a huge driver of the 1970s Great Inflation — the rise in the […]
September 7th, 2013 at 11:42 am PDT
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[…] Steve Waldman has responded to my recent post claiming that the inflation of the 1970s was a monetary phenomenon. He still insists it’s more useful to think of it as a demographic phenomenon. Let me try to explain my two objections in a different way. […]
September 7th, 2013 at 12:04 pm PDT
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“To say that policymakers [in the 1970s] erred or even misestimated, you’d have to claim they did not understand that their employment-focused policies might bring inflation. I think it’s pretty clear that they did understand that.”
Really?!?
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2126277
Arthur Burns and Inflation
Robert L. Hetzel
Winter 1998
Abstract:
“Arthur Burns, Chairman of the Federal Open Market Committee of the Federal Reserve System from February 1970 until December 1977, was fiercely opposed to inflation. Yet, over his eight-year tenure, prices increased at an annualized rate of 6.5 percent. Why? One reason was Burns’s belief that inflation arose from a variety of special factors, each of which was largely out of the control of the Federal Reserve.”
Page 22:
“In November 1970, the minutes of the Board of Governors show Burns telling the Board (Board Minutes, 11/6/70, pp. 3115–17) that
“…prospects were dim for any easing of the cost-push inflation generated by union demands. However, the Federal Reserve could not do anything about those influences except to impose monetary restraint, and he did not believe the country was willing to accept for any long period an unemployment rate in the area of 6 percent. Therefore, he believed that the Federal Reserve should not take on the responsibility for attempting to accomplish by itself, under its existing powers, a reduction in the rate of inflation to, say, 2 percent…he did not believe that the Federal Reserve should be expected to cope with inflation single-handedly. The only effective answer, in his opinion, lay in some form of incomes policy.”
(The term “incomes policy” is a catchall expression for various forms of direct intervention by the government to control prices.) Those comments reflected a reading of the domestic situation that was particular to the time. Again, a different time would have yielded a different monetary policy.”
Pages 36-37:
“Both Burns and the economists in the Nixon Administration believed that the special factors that were exacerbating inflation in 1973 would dissipate in 1974 and, consequently, inflation would decline. Nevertheless, inflation remained in the low double digits throughout 1974. For that reason, Burns remained a strong advocate of incomes policies to control inflation (U.S. Congress, 7/30/74, p. 258). However, on April 30, 1974, the President’s authority to impose wage and price controls expired. The Cost of Living Council, which had administered the controls, disappeared at the same time. Even though Burns lobbied hard for reestablishment of an incomes policy, the price-controls program had become discredited in Congress. Also, the key economic policymakers in the incoming Ford Administration, in particular CEA chairman Alan Greenspan and Treasury Secretary William Simon, opposed incomes policies.”
September 7th, 2013 at 1:12 pm PDT
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Steve Roth:
“You can argue about the answer, but this is sure: the rise in the labor force that Steve points out is crucial to thinking about The Great Inflation, and it’s been completely absent from the mainstream-storyline Great-Inflation explanations that I’ve wrestled with over the years.”
Really?!?
Katz and Krueger, 1999, Page 32:
“A venerable macroeconomic tradition examines the extent to which changes in the age and sex composition of the labor force can explain secular movements in the unemployment rate. The much higher unemployment rates for teenagers and young adults than for adults of prime working age make it plausible that changes in the age structure of the work force can substantially affect the unemployment rate. Seminal studies by George Perry and by Robert Gordon provide strong evidence that changes in the age and sex composition of the work force (the labor market entry of the baby-boom cohorts and a rapid expansion of female labor force participation) contributed to an increase in the NAIRU in the 1960s and 1970s.39 The convergence in male and female unemployment rates since the early 1980s indicates that the direct effect of sex-composition changes on the unemployment rate is unlikely to have been important over the past two decades. But recent studies by Robert Shimer and by Robert Horn and Phillip Heap suggest that age-structure changes driven by the maturing of the baby-boom cohorts can account for a substantial part of the lower unemployment in the 1990s than in the 1970s and 1980s.40 In this section we reassess the role of age-structure changes and explore the possible consequences for the NAIRU of continuing secular increases in the educational attainment of the adult work force.”
http://www.brookings.edu/~/media/Projects/BPEA/Spring%201999/1999a_bpea_katz.PDF
Ball and Mankiw, 2002, Page 125:
“The most obvious reason the labor force changes is demographics. In seeking to explain the evolution of the NAIRU, a number of authors point to a particular type of shift: the changing age structure as the baby boom generation has moved through the labor force. The proportion of the labor force aged 16 –24 rose from 17 percent in 1960 to 24 percent in 1978 as the baby boomers entered the labor force as young workers, and this percentage fell to 16 percent in 2000 as the boomers have aged. These trends are potentially important because young workers have higher unemployment rates than older workers: over 1960–2000, the average unemployment rate was 12.2 percent for workers 16–24 and 4.4 percent for workers 251. Gordon (1998) has argued that the increase in young workers accounts for much of the increase in the NAIRU before 1980, and Shimer (1999) argues that the recent decrease explains much of the NAIRU fall.
The classic method for measuring the effects of demographic changes is to compute a “Perry-weighted” unemployment rate (Perry, 1970; Katz and Krueger, 1999). This is a weighted average of unemployment rates for different demographic groups with fixed weights; by contrast, the usual aggregate unemployment rate has weights equal to labor-force shares, which change over time. A time series for Perry-weighted unemployment shows what would have happened to the unemployment rate given the evolution of each group’s unemployment if the sizes of groups did not change.”
http://scholar.harvard.edu/files/mankiw/files/jep.ballmankiw.pdf
Changing Labor Markets and Inflation
George L. Perry
1970
[No Abstract]
http://www.brookings.edu/about/projects/bpea/editions/~/media/Projects/BPEA/1970%203/1970c_bpea_perry_schultze_solow_gordon.PDF
Inflation, Flexible Exchange Rates, and the Natural Rate of Unemployment
Robert J. Gordon
December 1982
Abstract:
“The most important conclusion of this paper is that the growth rate of the money supply influences the U.S. inflation rate more strongly and promptly than in most previous studies, because the flexible exchange rate system has introduced an additional channel of monetary impact, over and above the traditional channel operating through labor-market tightness. Lagged changes in the effective exchange rate of the dollar, through their influence on the prices of exports and import substitutes, help to explain why U.S. inflation was so low in 1976 and why it accelerated so rapidly in 1978. Granger causality tests indicate that lagged exchange rate changes influence inflation, but lagged inflation does not cause exchange rate changes. A policy of monetary restriction in the 1980s is shown to cut the inflation rate by five percentage points at about half the cost in lost output as compared with the consensus view from previous studies. The paper defines the “no shock natural rate of unemployment” as the unemployment rate consistent with a constant rate of inflation in a hypothetical state having no supply shocks and a constant exchange rate. A new estimate of this natural rate concept displays an increase from 5.1 percent in 1954 to 5.9 percent in 1980 that is entirely due to the much-discussed demographic shift in labor-force shares and relative unemployment rates. Other higher estimates of the natural unemployment rate, close to 7 percent in 1980, result from the use of a naive Phillips curve that relates inflation only to labor-market tightness and inertia variables. The paper contains extensive sensitivity tests that examine the behavior of the basic inflation equation over alternative sample periods; that enter the growth rate of money directly and track the behavior of a money- augmented equation in dynamic simulation experiments; and that test and reject the view that wage-setting behavior is dominated by “wage-wage inertia”, that is, the dependence of wage changes mainly on their own past values.”
September 7th, 2013 at 2:17 pm PDT
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Link for Robert Gordon paper:
http://www.nber.org/papers/w708
September 7th, 2013 at 2:18 pm PDT
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Mark — Thanks for the Hetzel cite! A really nice paper overall, despite just a bit of glib editorializing.
You’ll note that in almost every quote, Burns acknowledges that monetary restraint could combat inflation, but that in his view, the collateral damage would be too great and other alternatives would be superior for addressing inflation. In the language I use, Burns chose to risk inflation, because the tool that he knew he had at his disposal to address it would be too costly in terms of employment and other goods, and he thought there were other tools. Perhaps Burns underestimated that risk, and overestimated the likelihood that other tools would be deployed or would be effective. It’s easy to argue that in retrospect! But it’s not clear he was always wrong, either.
I’m going to excerpt some quotes of Burns’ from the article. I’ll start with the bit you quote, and add emphasis:
Here’s more! Lots more! Burns, long before he was Fed Chair, was devoted to full employment:
Burns considered, and explicitly rejected the full Volcker, not because it would be ineffective at combating inflation, but because in his view the collateral damage would be too great:
Here’s an almost Sumnerian acknowledgement that the central bank can offset fiscal policy, attached to an evaluation that the costs of doing so would be unacceptable.
More, specifically related to unemployment:
Explicit prioritization of employment over inflation:
Explicit disavowal of a fixed Phillips Curve (albeit used to make an optimistic case of no certain trade-off rather than the recently conventional pessimistic case of trade-offs worse than you’d think):
More acknowledgement of the power of monetary policy to combat inflation, but argument that the employment cost would be too high:
The Burns in this article comes off as guilty of a kind of self-serving optimizing, of imagining that various sorts of “incomes policy” or price controls or other interventions would relieve the country, and especially its central bankers, of painful trade-offs between inflation and employment (or “prosperity”). But it’s very clear that Burns perceived and understood those trade-offs in the absence of his (in retrospect fanciful) alternatives.
But a fair reading of the article is not damning of Burns is if you are sure that controlling inflation via aggressive monetary restraint would not have been unduly costly in terms of employment, financial stability, and social peace. If you are certain that Volckeresque restraint would have been as tolerable in the early 1970s as it was in the 1980s, if you believe that P is just a number proportional to M that can be near-costlessly adjusted by the central bank, than you will mock. But we cannot run that experiment, and I don’t know what evidence you’d use to support the contention that Fed-engineered recessions just as Boomers were coming into the market, in the shadow of Vietnam and race riots, would not have led to intolerable costs.
It is unfashionable now to describe inflation as multicausal, and after decades of ridicule of “cost-push inflation”, it is easy to read Burns as self-evidently obtuse. But he was not obtuse, and it is not even clear he was wrong about very much other than his optimism about alternative tools. (There’s lots I might disagree with, but that’s not the same as being clearly wrong. Many economic questions remain open except to people whose minds have closed.)
We all agree, including Burns, that central bank restraint could have stopped the inflation in its tracks. None of us know whether Burns was right that the cost of that policy meant it was better to try alternatives than to take that path. In my view, given the social and demographic facts of the 1970s, there was real danger of outcomes much worse than we actually experienced. I won’t argue that Burns’ policy was in any sense optimal — optimality in general is too much to hope for in a fallen world — but the choices he made were not ex ante unreasonable, even given what we know today. It was the Greenspan Fed that admitted to holding policy atypically loose in the 2002-2003 in order to manage asymmetric risks. The Fed perceived the costs of further disinflation or deflation to be higher than those of inflation or bubbles, so it skewed policy loose. The downside risks of the early 2000s strike me as small relative to those of the early 1970 to mid-1970s. Sure, Japanese-style deflation or hitting the zero-bound was not an issue then. But were… other risks.
This bit from Burns in the Hetzel article strikes me as interesting:
Post-1980s, conventional wisdom has been to claim that inflation was a monetary phenomenon, and that to break it, all we ever needed was a Volcker. But based on the same experience, one might argue with Burns that inflation was a “wage-price” “cost-push” effect of labor bargaining power, a phenomenon addressed by Reagan and Japanese auto manufacturers more Volcker. We only have one dramatic disinflation experiment, and despite the self-congratulation of some economists ex post, Burns’ view of inflation an multi-causal remains current and wins on parsimony. It’s clear that the multi-pronged remedies Burns desired failed, either because they were impotent or because they were insufficiently implemented during his tenure. But that is really all that is clear.
September 7th, 2013 at 3:13 pm PDT
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Steve,
But you’re leaving out the best parts.
Burns had a credit view of monetary policy in that it worked through its influence on the credit market. And monetary policy was only one factor affecting credit markets. Thus monetary policy could be overwhelmed by other factors. He had a “real” or nonmonetary view of inflation in that inflation could arise from a variety of sources other than just money. He believed that a central bank could cause inflation by monetizing government deficits but did not attribute inflation to that source in the early 1970s, but instead, he attributed it to the exercise of monopoly power by unions and large corporations
Pages 34-35:
“Burns did not consider money to be a major independent influence on economic activity or inflation. For Burns, the fundamental determinant of economic activity was the confidence of businessmen. As a result, Burns emphasized not the rate of growth of money but its short-run velocity, which he believed reflected that confidence. At the December 1974 FOMC meeting, Burns stated (FOMC Minutes, 12/17/74, pp. 1312–14 and 1338):
“The willingness to use money—that is, the rate at which money turned over, or its velocity—underwent tremendous fluctuations; velocity was a much more dynamic variable than the stock of money, and when no account was taken of it, any judgment about the growth rate of M1 was likely to be highly incomplete. . . . Fundamentally, velocity depended on confidence in economic prospects. When confidence was weak, a large addition to the money stock might lie idle, but when confidence strengthened, the existing stock of money could finance an enormous expansion in economic activity.”
Money was important, but only as it affected interest rates. Burns saw monetary policy through the optic of credit markets. With interest rates being the measure of monetary ease or tightness, monetary policy could be restrictive even if money growth was rapid. Burns testified to Congress (U.S. Congress, 6/27/73, p. 185):
“We began applying monetary restraint as early as March of 1972. This is reflected in interest rates. . . . I do not want to leave you with the impression that . . . we went much too far in the growth of the aggregates [in 1972]. I do not think we did.”
In 1973 and 1974, as inflation rose sharply, Burns became sensitive to monetarist criticism of the Fed for allowing high rates of M1 growth. In 1973 and the first half of 1974, the FOMC, with Burns’s encouragement, moderated the M1 growth. However, while acknowledging that inflation could not continue without rapid money growth, Burns challenged the monetarists by arguing that rapid money growth had followed inflation, rather than preceding it. Burns testified (U.S. Congress, 7/30/74, p. 257):
“The current inflationary problem emerged in the middle 1960s when our government was pursuing a dangerously expansive fiscal policy. Massive tax reductions occurred in 1964 and the first half of 1965, and they were immediately followed by an explosion of Federal spending. . . . Our underlying inflationary problem, I believe, stems in very large part from loose fiscal policies, but it has been greatly aggravated during the past year or two by . . . special factors. . . . From a purely theoretical point of view, it would have been possible for monetary policy to offset the influence that lax fiscal policies and the special factors have exerted on the general level of prices. One may, therefore, argue that relatively high rates of monetary expansion may have been a permissive factor in the accelerated pace of inflation. I have no quarrel with this view. But an effort to use harsh policies of monetary restraint to offset the exceptionally powerful inflationary forces of recent years would have caused serious financial disorder and dislocation.
When Burns became Chairman of the FOMC in February 1970, economic activity had fallen for two months from its December 1969 cyclical peak. During the recession of 1970, inflation failed to decline. Burns drew the conclusion that the contemporaneous inflation arose primarily from a rise in wages due to the exercise of monopoly power by labor unions. In a speech before the American Economics Association, Burns ([12/29/72] 1978, pp. 143–54) stated:
“The hard fact is that market forces no longer can be counted on to check the upward course of wages and prices even when the aggregate demand for goods and services declines in the course of a business recession. During the recession of 1970 and the weak recovery of early 1971, the pace of wage increases did not at all abate as unemployment rose. . . . The rate of inflation was almost as high in the first half of 1971, when unemployment averaged 6 percent of the labor force, as it was in 1969, when the unemployment rate averaged 3 1/2 percent. . . . Cost-push inflation, while a comparatively new phenomenon on the American scene, has been altering the economic environment in fundamental ways. . . . If some form of effective control over wages and prices were not retained in 1973, major collective bargaining settlements and business efforts to increase profits could reinforce the pressures on costs and prices that normally come into play when the economy is advancing briskly, and thus generate a new wave of inflation. If monetary and fiscal policy became sufficiently restrictive to deal with the situation by choking off growth in aggregate demand, the cost in terms of rising unemployment, lost output, and shattered confidence would be enormous.”
President Nixon imposed wage and price controls on August 15, 1971. This offered a tailor-made experiment of Burns’ views. The controls worked as intended in that they held down wage growth and the price increases of large corporations. Nevertheless, inflation rose to double digits by the end of 1973.
Page 36:
“Burns attributed the inflation that began in 1973 to a variety of special factors (U.S. Congress, 2/1/74, pp. 669–70):
“In retrospect, it might be argued that monetary and fiscal policies should have been somewhat less expansive during 1972, but it is my considered judgment that possible excesses of this sort were swamped by powerful special factors that added a new dimension to our inflationary problem. . . . A major source of the inflationary problem last year was the coincidence of booming economic activity in the United States and in other countries. . . . Another complicating factor was the devaluation of the dollar. . . . disappointing harvests in 1972—both here and abroad—caused a sharp run-up in prices. . . . In short, the character of inflation in 1973 was very different from the inflation that troubled us in different years. A worldwide boom was in process; the dollar was again devalued; agricultural products, basic industrial materials, and oil were all in short supply.”
So then Burns attributed inflation to special factors, such as increases in food prices due to poor harvests and in oil prices due to the restriction of oil production. However, special factors are by nature one-time events. In 1974, inflation should have fallen as the effect of these one-time events dissipated, but it remained at double-digit levels that year.
Page 37:
“In the last half of 1974, with an incomes policy no longer viable and with inflation continuing unabated, Burns returned to the themes of government spending and deficits as the primary cause of inflation. He testified to Congress 8/21/74, p. 213), “The current inflation began in the middle 1960s when our government embarked on a highly expansive fiscal policy.” And again, Burns testified (U.S. Congress, 9/25/74, p. 119):
“. . . special factors have played a prominent role of late, but they do not account for all of our inflation. For many years, our economy and that of most other nations has been subject to an underlying inflationary bias. . . . The roots of that bias . . . lie in the rising expectations of people everywhere. . . . individuals and business firms have in recent times come to depend more and more on government, and less and less on their own initiative, to achieve their economic objectives. In responding to the insistent demands for economic and social improvement, governments have often lost control of their budgets, and deficit spending has become a habitual practice. Deficit spending . . . becomes a source of economic instability . . . during a period of exuberant activity.”
Burns told the FOMC, “While the U.S. inflation was attributable to many causes, a large share of the responsibility could be assigned to the loose fiscal policy of recent years” (FOMC Minutes, 5/21/74, p. 669).”
Pages 37-38:
“Ultimately, Burns attributed the effect of the deficit on inflation to its influence on the psychology of businessmen. Because the deficit symbolized a lack of government discipline, it lessened the willingness of businessmen to exert the discipline required to hold down wages and, as a consequence, prices. The importance that Burns placed on the psychological effects of the deficit are evident in his comments both at FOMC meetings and at congressional hearings. At one FOMC meeting, Burns made his point by taking a shot at the Keynesianism of the Board staff (Board Minutes, 12/16/74, p. 1261):
“The Chairman then asked what the staff thought the net effect would be of a simultaneous decrease of, say, $20 billion in both Federal expenditures and business taxes. In response, Mr. Pierce said the econometric model would indicate that such a policy was deflationary, on balance, because it wouldresult in a rise in savings. Chairman Burns observed that in his opinion the effects would be strongly expansionary rather than deflationary; a $20 billion tax cut would create a wholly new environment for business enterprise, and businessmen would react by putting their brains, their resources, and the credit facilities to work. His disagreement with the staff on that point reflected a basic difference in interpretation of how the economy functioned and how fiscal stimulants and deterrents worked their way through the system. According to Burns, a reduction in the deficit would both stimulate economic activity and reduce inflation. He testified to Congress (8/6/74, pp. 225–26 and 229):
“If the Congress . . . proceeded to cut the budget . . . then confidence of business people, and of heads of our households, that the inflation problem will be brought under control would be greatly enhanced. In this new psychological environment, our trade unions may not push quite so hard for a large increase in wage rates, since they would no longer be anticipating a higher inflation rate. And in this new psychological environment, our business people would not agree to large wage increases quite so quickly. Therefore, these indirect effects of a cut in the Federal budget of $5 [billion] or $10 billion can in such an environment be vastly larger than what the mathematical models . . . suggest. . . . If this Congress were to vote this day . . . a cut of $10 billion in spending, the stock market would revive promptly, the bond market would revive promptly, and short-term interest rates would move down promptly. . . . Forces . . . would be released within the private sector that would in time make more jobs for our people.”
So Burns then blamed inflation on government deficits. But according to Hetzel, as a percentage of GNP, the government (federal, state, and local) surplus or deficit was 1.1 in 1969, 1.0 in 1970, 1.7 in 1971, 0.3 in 1972, 0.5 in 1973, and 0.2 in 1974. The deficits of 1970 and 1971 reflected the recession.
Steve Randy Waldman:
“We only have one dramatic disinflation experiment, and despite the self-congratulation of some economists ex post, Burns’ view of inflation an multi-causal remains current and wins on parsimony.”
Actually we have dozens and dozens of such experiments and not all contemporaneous. Some countries, such as Japan, started to disinflate as early as 1974. Other countries, such as Australia, didn’t start until as late as 1990. But disinflation is now a near global phenomenon and every country that did it, did it through less expansionary monetary policy.
September 7th, 2013 at 6:01 pm PDT
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[I screwed this one up badly… I’ll try to repost when I’ve fixed it. Hope nobody saw it yet. Sorry!]
[It’ll have to be much later… I’m being rushed rushed rushed now.]
September 7th, 2013 at 7:06 pm PDT
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Mark — There is a lot of good stuff in the Burns quotes you’ve added! Some of it I agree with, some of it I don’t. Again, where Burns most clearly errs is where he suggests remedies that we now know were not effective, at least to the degree that it was possible to implement them. Still, the only people who would find Burns’ views as a corpus self-discrediting are those who’ve latched onto a very monocausal view of inflation and consider any alternatives to be laughable.
September 7th, 2013 at 7:13 pm PDT
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Steve:
“I’ve put together a correlation table using the single-prices all-prices monthly HICP data available from FRED. It’s 1996 to the present, prominently missing Japan. (I’m not sure why.)
You’ll notice that most of the correlations are approximately 1. The minimum correlation is 0.707. The minimum correlation of the US with any country is 0.835.
This is biased to some degree by European integration and its recency.”
Seventeen of those 31 countries are eurozone members. Another 3 are pegged to the euro. Before they were euro members most were pegged to the European Currency Unit (ECU), which effectively meant being pegged to the German mark. Some have been pegged to each other for a very long time. For example prior to the formation of the euro the Dutch guilder was essentially pegged to the German mark since 1983. It would be very surprising if there wasn’t a high degree of correlation.
Moreover, with few exceptions these countries have been targeting a low inflation rate since 1996. Thus most of the variation will be from food and energy prices, which are global in nature, further increasing the cross correlation. Finally, and probably most importantly, you are taking the cross correlation of data series that are all increasing over time. Thus they are bound to display a high degree of correlation, but the correlations are spurious and not very informative.
Steve:
“It’s less trivial to find comparable old data, but you’ve pointed out yourself the curious simultaneity of the Great Inflation. Regardless, I’d gladly wage that the point would stand with older data, that crosscountry inflation correlation coefficientss were strong and significant throughout the period.”
They same delusions concerning the role of monetary policy with respect to inflation was global and the knowledge of how to contain it spread nearly simultaneously, but not completely. As I just pointed out, 16 years separate Japan’s and Australia’s disinflation, and I only mention those because I spent some time studying those events recently. Were I to do a more systematic analysis I’m sure I can find a greater span of time between first and most recent incident of disinflation.
“This is also the problem with your claim in the previous post that demography and the Great Inflation don’t match elsewhere. No, they all basically match the demography of the country at the heart of the global monetary system. Hmm!”
This doesn’t disprove that inflation is primarily a monetary phenomenon, it proves it. Under Bretton Woods we essentially had a system of fixed exchange rates where all of the world’s economies were pegged to the dollar. When the US inflated its economy in 1966-73 it took the rest of the planet with it. This close correlation broke down with the demise of Bretton Woods and you can see that with the fact that some countries started to disinflate before others.
Also I think it’s a bit simplistic to explain the US Great Inflation purely on an increased NAIRU due to demographics. There were of course other factors at work.
“We might be able to draw useful lessons from differences cross country experiences. But it will be hard, and require careful econometrics to try to tease a little independence out of a lot of contamination.”
Certainly, but it’s much better than leaping to conclusions based on observing a single nation.
“Still, the only people who would find Burns’ views as a corpus self-discrediting are those who’ve latched onto a very monocausal view of inflation and consider any alternatives to be laughable.”
In the short run inflation is the result of shifts in AD (NGDP) and short run AS (SRAS). In the long run its determined by AD and long run AS (LRAS). Since AD is largely a matter of monetary policy inflation is mostly determined by monetary policy in the short run and almost entirely determined by monetary policy in the long run. Call that “monocausal” if you like.
September 7th, 2013 at 8:23 pm PDT
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[…] posts lately about the inflation of the 1970′s… Steve Randy Waldman, Steve Roth, Scott Sumner and me. Here is a graph of the inflation during the […]
September 8th, 2013 at 12:03 am PDT
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[…] posts lately about the inflation of the 1970′s… Steve Randy Waldman, Steve Roth, Scott Sumner and me. Here is a graph of the inflation during the […]
September 8th, 2013 at 12:06 am PDT
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Mark — You are far too generous with my correlation matrix, which I took down about 20 minutes after posting, but which, alas, you found.
As you point out too gently, I mistakenly used levels rather changes, which for these nearly always upward-trending series generates a very high level of correlation artificially. I put that together in a terrible rush, and, embarrassingly, I let confirmation bias stand-in for common sense, what little of that I ever have. I am sorry to have posted that at all.
A revised matrix correlating changes shows generally positive but more plausible modest correlations. Here’s that, FWIW. All your points about the limitations of the dataset remain accurate. We’ll need much better sources to tease out very meaningful empirics.
September 8th, 2013 at 12:37 am PDT
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Really, what you are arguing is not that 1970s inflation wasn’t a monetary phenomenon, but that it was not a merely pernicious monetary phenomenon.
September 8th, 2013 at 3:21 am PDT
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But it is still usefully described as a monetary phenomenon. If the US has still been on the gold standard, as it was after 1873 during the US’s late C19th population boom, would there have been “demographic-caused” inflation in the 1970s? Clearly not. Indeed, that late C19th population boom coincided with the 1873-1896 deflationary period. Trying to say some labour force surges count for inflation and others don’t seems somewhat like using your conclusion to set the ambit of your premises.
Your cancer analogy rests on there being only one likely effective response. But what if that is not the case? Why is not the sensible response to a flood of new labour be to make sure that blockages to use of labour are removed? I.e. supply-side policies. Even if you want to ramp up inflation a bit to get falls in real wages, is not how much you need to do that a trade-off with such supply-side policies? The great inflation then becomes a monetary phenomenon due to under-utilisation of supply side reforms.
Also, just come across a useful quote from Friedman, that the “essence” of his argument was: to suggest that monetary policy is an appropriate and proper tool directed at achieving price stability or a desired rate of price change. So, if monetary policy was appropriately (more or less) concerning itself with higher rates of price change to push real wages down enough to keep employment up in a situation of sticky nominal wages, how does that make the 1970s inflation not a monetary phenomenon? As per Milton’s framing?
September 8th, 2013 at 3:27 am PDT
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[…] Sandowski (in comments here and here) and Scott Sumner challenge me to support my thesis that inflation is related to demographics in […]
September 8th, 2013 at 7:22 am PDT
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[…] Agreeing in different languages […]
September 8th, 2013 at 7:45 am PDT
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I’d like to get down to the brass tacks on Burns.
He knew he could whip inflation, he however viewed it too painful.
He blamed the govt. for its fiscal policy, he was against it, and essentially refused to play the roll of independent task master, who must be indifferent to the policy choices of bad govt.
Steve, I don’t think you can say that’s a good kind of Fed Chair.
I think you should admit that behind a veil, if you had to choose, you’d prefer a rule based system, like a NGDPLT, you’d prefer Friedman’s Fed run by a computer.
And I think you should admit it, bc I think you also believe we are a nation of laws not men. And the economic equivalent of a rules based system, doesn’t have the Fed Chair bending over to the piss boy of the Congress.
MP can only “fix” bad Fiscal, by enforcing a fair knowable rule, and making Fiscal learn some painful lessons.
We set the Fed up as a backstop against bad Fiscal, we didn’t set it up to facilitate the will of Congress, to paper over bad fiscal.
We have too much Democracy already, the US is not meant head down the path towards Parliamentary govt. Towards a CB that is run by Treasury.
We have NGDPLT before us, if combines both inflation and growth, it is rules based, and it would have run the 1970’s DIFFERENTLY than it was run.
Basically, we look back on slavery and we don’t make excuses for it. We have a new better truth and we judge the past accordingly.
NGDPLT is our new better truth, we ought to apply is to make historical periods and see what they SHOULD have done.
September 8th, 2013 at 2:18 pm PDT
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[…] There’s great discussion out there on this topic, see Steve Randy Waldman’s links list here. […]
September 9th, 2013 at 10:51 am PDT
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[…] There’s great discussion out there on this topic, see Steve Randy Waldman’s links list here. […]
September 9th, 2013 at 10:54 am PDT
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[…] There’s great discussion out there on this topic, see Steve Randy Waldman’s links list here. […]
September 9th, 2013 at 10:55 am PDT
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[…] power and a surging labor force from desirous baby-boomers coming of age as pointed out by Steve Randy Waldman. (Desirous is my painting […]
September 9th, 2013 at 2:13 pm PDT
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[…] power and a surging labor force from desirous baby-boomers coming of age as pointed out by Steve Randy Waldman. (Desirous is my painting […]
September 9th, 2013 at 2:16 pm PDT
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[…] Steve Randy Waldman’s Interfluidity current […]
September 10th, 2013 at 10:47 am PDT
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I am with Waldman @ # 15: People @ and around the Fed understood they were facing a trade-off. A real unemployment rate of 4% versus an guesstimated NAIRU @ 6 or 7. Almost all the heavies at the time were preoccupied with the real world trade-off btw unemployment and inflation. RATEX and the NAIRU would relieve the future generations of economists from giving a shit for the sons and daughters of the prols that liberated Europe. Theirs was to be war of high unemployment and high interest rates. Doubt me here is Solow @ the After the Philips Curve Conference sponsored by the Boston Fed in 78:
“While I am confessing, I also worry a lot about U*, the natural rate of unemployment… I even have trouble with the vertical long-run Phillips curve. I see its attractions very clearly, and I saw them at the very beginning. In fact, there is a peculiar inner conflict here. Deep down I really wish I could believe that Lucas and Sargent are right, because the one thing I know how to do well is equilibrium economics. The trouble is I feel so embarrassed at saying things that I know are not true. The long-run vertical Phillips curve seems so inevitable… What is the value of U*? What unemployment rate should policy aim at?
Should I believe 5 1/2 percent for now as Wachter [conference participant] tells me I should, or should I believe the 6 percent that Henry Wallich tells me I should, or should I believe the people who tell me that whatever the unemployment rate is today is the natural rate of unemployment for today?”
…..
“…you have to have a very good reason for believing that the natural unemployment rate is 5 1/2 percent if you want to go out and face all those people who are unemployed. It is no joke. For statisticians it is just numbers, just something that comes out when you set something equal to zero and divide one number by another. But those fellows out there are not working. You ought to be sure of what you are talking about, and that the right figure is 5 1/2 percent and not 3 1/2 or 4 1/2 percent before you pretend that it has some relevance to practical life.”
September 10th, 2013 at 8:59 pm PDT
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A&F
September 11th, 2013 at 10:11 pm PDT
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