This week Bruce is joined by Robert J. Samuelson. He is an award winning columnist and author. He has been writing a column for The Washington Post since 1977, and for Newsweek since 1984. He has recently published a book named The Great Inflation and Its Aftermath: The Past and Future of American Influence.
In discussing the similarities between the Great Depression and the great inflation, Samuelson wrote, “What ultimately governed their decisions was the conventional wisdom at the time. The policies had been set with egos at stake. They were presumed to be correct.”
Bruce asks what the conventional wisdom in the 1960s was in regards to creating a healthy economy. The conventional wisdom in the 60s was called Keynesianism. This term was coined from John Maynard Keynes; a British economist who died in 1946. Keynesianism lead people to believe that professional economists had concurred the business cycle. Economists had figured out how to forecast the economy, and they had the tools to counteract recessions. Economists believed they could maximize economic growth, and keep unemployment at very low levels. This mentality lead people to believe that they could bring about endless prosperity.
The Philips Curve was named after the Australian economist A.W. Philips. Philips postulated that there was a fixed trade off between higher inflation and lower employment. You could pick which poison/benefit you desired to receive by raising one and lowering the other.
Walter Heller was chairman of Kennedy’s council of economic advisors. Kennedy was a person who truly listed to his advisors. Bruce asks if the economic thought of the time was played out in Kennedy’s policy. Although Kennedy was a practical politician, he was open to new ideas. His advisors argued that the policies which Eisenhower followed in the 1950s were behind the times. Heller argued that economists could prevent recessions, keep unemployment lower, and maximize economic growth. Kennedy was a skeptic at first because he had been raised to believe that the government should balance its budget, and inflation was a bad thing. Heller argued that we could use federal budget deficits to manipulate the economy, and even if a little inflation resulted, it wasn’t a terrible thing because you would have lower unemployment and people would adjust to it. Since the economy of Kennedy’s first two years did not do incredibly well, and because he was genuinely curious, he was open to the idea of inflation. The ideas that Heller sold to Kennedy were embraced by most economists.
This theory of a stable trade off between inflation and unemployment was obviously wrong. Economists could not create a fixed rate of inflation. In fact, we got an ever-accelerating rate of inflation. When Kennedy first became president, the inflation rate was between 1 and 2 percent, but by the end of the 60s, it was 6 percent, and by the end of the 70s, it was 14 percent. Having this rising inflation made the economy less stable. Between the end of the 60s and the early 80s, we had 4 recessions of increasing severity. The recession of the early 80s had a peak unemployment rate of 10.8 percent. The net result of this economic experiment was that everything turned out to be completely the opposite of what the economists had promised. It promised stable inflation, but didn’t get stable inflation. It promised fewer business cycles and recessions, but we got more business cycles and recessions. It promised lower average unemployment, but we got higher unemployment.
The general idea of inflation is starting to become popular again. The chief economist of the International Monetary Fund recently put out a paper saying, “Maybe a little bit of higher inflation is okay.” Hearing this, Samuelson thought, “Haven’t they learned anything in the last 50 years?”
We were in a desperate position in 2008, and the idea of the economic stimulus program was desirable. However, Samuelson does not think that this program was executed well. The economy was in the process of falling off the edge. The idea of people being able to manipulate the business cycle seems ultimately self defeating. We have to intervene, but we have to be more restrained in our interventions. When interventions succeed, they create conditions that strike back at us.
If Robert wanted to make a formula for creating inflation, the most important ingredient would be to not care about inflation; to not care about keeping the money supply stable. This old fashioned idea that stable money is a responsibility of the government seems to be an ancient relic of the barbarian past. Robert thinks that responsibility is extremely important. The mindset of decision of makers, and the public, is the most important thing. Also, creating too much easy credit is a precondition for most sustained inflations. You can have easy credit, an easy monetary policy, and an expansive money supply, and not get inflation if there are other things off-setting the monetary stimuli. However, if you have people in charge who don’t care about inflation then you are preconditioned to have higher inflation.
Bruce will return to this topic in the next segment.
Samuelson remarked that the learning curve of successive presidents and their advisors is remarkably flat. It amazes Bruce that we have very intelligent people running our government, yet there has been no progressive learning curve. The same mistakes were made as new presidents came into power. Bruce wonders what role politics played in swaying the economic policy of the 70s. In the 60s, economists persuaded political leaders that it was possible to have sustained economic growth, with few recessions, and low unemployment. Once those ideas were accepted by political leaders, it became a part of the fabric of the public’s expectation. When these ideas did not accomplish their purpose, other people tried to achieve the same goal using different policies. Essentially, they continued to use bad policies to prop up a structure which was already collapsing. Unfortunately, our leaders were not able to admit and act as thought they were incapable of solving our financial problems. It fell to Ronal Reagan to deliver the news that their promises could not be fulfilled.
Arthur Burns was the Federal Reserve chairman from 1970 to 1979. He was an economist from Colombia University. He was also the head of the National Bureau of Economic Research. His major mistake was that he bought into Keynesianism. Once he bought into it, he did not take the actions he needed to prevent inflation. In Samuelson’s book, he stated, “What was politically convenient, was also rationalized intellectually.” He was pressured from Nixon, and he was politically expected to fulfill the goal of constant economic growth with no business cycles. At some point, the Federal Reserve would have to stop the rising inflation, so they would tighten credit and reduce the money supply. This would cause a recession, which made the people upset, and so they would start the inflation process again. The Federal Reserve couldn’t decide how to solve the financial problem, and they ended up choosing to do nothing constructively.
Samuelson believes that if you have expectations of higher inflation, then you will get higher inflation. This kind of thinking makes businesses and workers act in such a way as to produce it. Businesses start thinking that they can pass on any price increases, and workers assume that they can get increased wages to pay for their higher cost of living. This mentality causes a wage/price spiral. Unless the government steps in and stops this mentality, it will continue.
At the end of World War II, there was a huge burst of inflation, because during the war we had wage/price controls. As soon as the artificial suppression of the wages and prices was removed, there was a huge increase in inflation. However, we did not get double digit inflation in the late 40s or the 50s. This makes Samuelson ask the question, “Why didn’t that happen?” This wasn’t because policy became oppressive; it was because people didn’t expect the wages and prices to continue to increase. People at that point in time didn’t think that the U.S. was going to have inflation for forever, so they didn’t act that way.
At the end of the 70s, people were scared by inflation. They feared that the government could not control inflation, and they didn’t understand inflation. They didn’t know whether their wages would keep up with rising prices, they didn’t know if their savings would be eroded by rising prices, and they didn’t know how high interest rates were going to go. In the early 80s, mortgage rates got up to 15 percent.
Bruce Norris refinanced his house to become a real estate investor at age 17. People didn’t know if that kind of inflation would continue. Opinion polls showed that people did not think the future would be better than the past. The fears then, and the fears now, are not that much different from each other.
Samuelson believes that the fear, anxiety, and pessimism induced by inflation were the main reasons Ronal Reagan was voted as president in 1980. The vote wasn’t about conservative vs. liberal politics. They didn’t know if Reagan could fix the problem, but they certainly knew that Carter couldn’t. This change in public perspective gave Volcker and Reagan a chance to try something new. They were the right pair to make those changes. Volcker was chairman of the Federal Reserve board at the end of the 1970s. Volcker was chosen to be chairman of the Federal Reserve, because Carter had hired the previous chairman to take the position of Treasury Secretary.
Volcker and Reagan shared the belief that the country could not prosper with double digit inflation. Volcker decided that the government was not going to pump out money and credit. After that decision, interest rates increased, inflation slowed down, and the economy went into a horrific recession. Reagan did something that no politician would have done at the time; he supported Volcker’s decision. This caused Reagan’s popularity to plummet, but he continued to give Volcker his support, because he thought Volcker was making the right decision.
What was unique about Reagan and Volcker’s policy was that all of the adverse consequences were up front. No politician likes to have the news filled with negative information related to their presidency. From Samuelson’s perspective, any other politician who had been president would have told Volcker to stop. If Volcker did not stop, then they would have created legislation to change the nature of the Federal Reserve, so that it would be more accountable to its political masters.
Bruce encourages everyone to get “The Great Inflation and Its Aftermath: The Past and Future of American Influence”. Roger will be on The Norris Group’s Radio Show during the next segment.