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November 9, 2008
David Warsh, Proprietor


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Frame Tale

You might think that in the midst of what is widely billed as the worst economic crisis in seventy-five years, I would have better things to read than a history of inflation. You would be wrong.  Hardly anything could be timelier. Robert J. Samuelson’s The Great Inflation and Its Aftermath: The Past and Future of American Affluence is a wonderful goad to meditation about where the world has been and where it may go next.

 

It is not so much the specter of inflation that worries me. It is climate change. But that’s getting ahead of the story.

 

The pace of the recession is accelerating. The Labor Department reported Friday another 240,000 jobs lost in October – 1.2 million jobs eliminated so far this year. The unemployment rate hit 6.5 percent, rising swiftly towards the 8.5 percent that is the consensus forecast for next year’s top.  Up from 4.4 percent early last year, that would constitute, if it is reached, the greatest trough-to-peak rise in the jobless rate since World War II – hard times, but not as hard as the recession of 1982, when unemployment his 10.8 percent, up from 7.0 percent.

 

That’s where Samuelson comes in. We are still far from having a clear idea of where the current recession came from and, fragility aside, how bad it is and how it will fit into our story in the coming years. Certainly there is a pervasive air of emergency.  But we do have a pretty widely-subscribed account of the whys and wherefores of the 1980-82 recession. That is the story Samuelson tells in The Great Inflation and its Aftermath. It has a good deal of bearing on the present day.

 

“We know that double-digit inflation ended,” writes Samuelson. “What now seems unremarkable (so unremarkable that people hardly recall it) appeared impossible then. If you had asked Americans in the fall of 1980, with inflation at 11 percent or more, the odds of reducing it to less than 4 percent by the end of 1982, the response would have been a collective howl.”

 

Indeed, it is hard to convey the feeling of free-fall, of anger and general helplessness that obtained in the autumn of 1980. In a single month, the price of silver jumped 53 percent (gold rose 28 percent); home break-ins surged around the country, as burglars sought out  family silver for its melt-value. Double-digit inflation was generally understood to be a malign consequence of human nature, quite beyond the ability of political leaders to control. Yet what happened next was that inflation not only subsided, but also returned to levels not seen since the 1950s, when it was a matter of concern to only a fussy few.

 

So how did inflation get going in the first place? Why did it stop? Samuelson delivers an answer in the form of a cautionary tale.  The Great Inflation of the second half of the twentieth century, he says, was mainly a story of expert opinion gone awry.  It was the second major blunder committed by the Fed in its first century of existence, he says. The first was permitting the Great Depression.  In each case, he writes, “the failure was not so much of inept individuals as of faulty doctrines.”

 

The Fed’s failure in the first instance is well documented, thanks to Milton Friedman and Anna Jacobson Schwarz. They argued, in A Monetary History of the United States 1867-1960 (1963), that the men running the US central bank in the early 1930s permitted a disastrous contraction of the money supply at precisely the moment when they should have been flooding the American economy with liquidity. Such was the rhetorical force of their careful empirical work that this “monetarist” view undermined most standard Keynesian interpretations of those events and subsequently largely carried the day among economists and policymakers.

 

Chapter seven of that landmark study was published separately as The Great Contraction. A new edition of it has just appeared which includes a new preface by Schwartz, an introduction by Peter Bernstein and the remarks of Ben Bernanke at Friedman’s 90th birthday celebration at which the current chairman of the Fed offered a famous toast:  “I would like to say to Milton and Anna, regarding the Great Depression:  You’re right, we did it.  We’re very sorry, but thanks to you, we won’t do it again.”

 

About that other “blunder” – the inflation that began in the early 1950s, gradually accelerated in the 1960s, and rose to roller-coaster heights in the 1970s, before subsiding after 1980 – the Fed’s responsibility is much less firmly nailed down: witness the fact that hardly anyone who lived through an episode that unfolded over so many years actually refers to “the Great Inflation.” But then that’s the task that Samuelson aims to accomplish with his book, by retrieving what he describes as a “lost history.”

 

Specifically, he says, a series of permissive errors was the result of an obsession with full employment on the part of Keynesian economists. Aspirations to “fine-tuning” were an exercise in hubris, as was the conviction that recessions were “fundamentally preventable, like airplane crashes and unlike hurricanes,” in the words of Arthur Okun, of Yale University and the President’s Council of Economic Advisers.  The economists who worked for Presidents John Kennedy and Lyndon Johnson saw fiscal policy – shifting taxes and spending – as their principal tools and the Fed’s monetary policy as a not-very-interesting accessory to them.

 

But the biggest mistake of the “new economics” was to assume that most people wouldn’t mind a little inflation, or, rather, that they shouldn’t mind it:  “there is a vast exaggeration of the social costs of inflation,” complained Yale’s James Tobin as late as 1974. But stable prices, says Samuelson, are far more important to orderly civic life than has been generally recognized.  The purchasing power of money, if it remains the same over many years, provides a sense of security and the confidence to undertake expansions of trade.

 

So what brought the Great Inflation to an end?  Samuelson describes the alliance between Fed chairman Paul Volcker (who had been appointed by President Jimmy Carter in 1979) and the newly elected President Ronald Reagan as – “a compact of conviction.”  Despite the chorus of expert doubt that inflation could be reduced at acceptable cost, Volcker persuaded his fellow governors to raise interest rates to unprecedented levels and to keep them high as the US entered a deep W-shaped recession. Reagan provided political support.

 

Their alliance was accidental, “unspoken, impersonal and misunderstood.” There was no personal chemistry, no explicit bargain.  But “both men believed, mostly as a matter of faith, that high inflation was shredding the fabrics of the American economy and of American society,” and that the country would not flourish if it continued. And so they permitted the monetary scourge to continue, easing finally in August 1982, when the international financial system threatened to buckle.

 

And sure enough, the disinflation that proceeded gradually after 1982 was accompanied by a quarter century of prosperity, punctuated by a pair of mild recessions ten years apart.  China joined the world economy.  The Soviet Union collapsed. Capitalism was restored.

 

All this rings true to me. The blunder view has become the dominant interpretation among economists.  I am not sure that Samuelson is right in thinking that the Fed could have prevented rising prices altogether. A great many developments were occurring in the “real” economy in those years – technical change, changing preferences, global integration – any and all of which may have forced central bankers’ to accommodate them and so had their effect on the cost of living. But there’s no doubt the process got out of control, and he’s especially good on the political will that was necessary to bring matters back from the brink in a moment of genuine bewilderment and despair.

 

Samuelson wrote this story, incidentally, because he lived it. He is no relation to Paul Samuelson, the Nobel laureate. Instead he is a newsman through and through, one of the generation who went to school on Vietnam war finance and economic news of the 1970s. Others include Paul Solman, of The News Hour with Jim Lehrer; John Berry, of Bloomberg; Paul Blustein, of The Washington Post for many years, and now the Brookings Institution; Allan Sloan, of Fortune magazine, Lou Uchitelle, of The New York Times; and me. Each of us found a particular niche. It was when Samuelson left the National Journal in 1984 to become, with consumer affairs writer Jane Bryant Quinn, the voice of Newsweek’s business section, replacing Lester Thurow and Milton Friedman, that he became the central figure on the landscape of economic journalism, or so it seems to me.

 

After all, Time had put John Maynard Keynes on its cover in 1965. A few months later Newsweek editor Osborne Elliott recruited three economists little known outside the field to write rotating columns in the business section – according them star status virtually unheard of in those days. Henry Wallich, of Yale, who was said to represent the vital center, dropped out in 1974, after he was appointed a governor of the Federal Reserve Board. But Samuelson, of the Massachusetts Institute of Technology, and Friedman, of the University of Chicago, slugged it out until 1982, when Samuelson dropped out and was replaced by Thurow.

 

So when Newsweek editor Richard Smith replaced the economists with a pair of professional reporters in 1984, it was a clear sign that the change that had begun in Washington had been ratified on Madison Avenue.  Although Smith didn’t exactly say it at the time, economics had been judged to be too important to leave to the economists.  Samuelson, his column appearing regularly in The Washington Post as well (Newsweek’s corporate parent), went on to become a dominant authority – perhaps the dominant authority in the press – in the battles over government deficits in the 1990s that led all-too-briefly to budget surpluses.

 

The implicit moral Samuelson draws from the story in The Great Inflation and Its Aftermath is, Don’t Trust the Experts.   They screwed up before and they will do it again.  He labels this “the curse of good intentions.” Ambitious attempts to ameliorate designated problems such as unemployment can backfire and make matters worse.

 

And that brings us back to climate change. At the end of his book, in a survey of problems facing the US (renewed inflation, uncontrolled entitlements, China), Samuelson says that “based on what we know now, it is a fairly intractable problem.”  Many anti-global warming measures offer a bad bargain to the US:  they penalize economic growth but achieve little. The potential for unintended consequences is very great. Exhibit A:  the subsidy for ethanol from corn that helped push up food prices. Only major technological changes can break the dilemma. But the political bias is for easy tricks and avoidance.

 

This counsel of caution and despair is undermined, I think, on two counts by the very story that Samuelson tells in The Great Inflation and Its Aftermath.  The first moral of Samuelson’s book is that, thanks to the work of Friedman, Schwartz and many others, the Fed clearly has learned from its mistakes. The central bank may commit other blunders in the years ahead, it is true.  But when Bernanke assured Friedman and Schwartz that “Thanks to you, we won’t do it again,” there is reason to believe, no further away than the front pages of the daily newspapers, that he knows how to avoid turning a scare into a Great Depression. What about renewed inflation?  With Federal deficits soaring to record levels, that will be a story worth watching for years to come.  But there is reason to think that in these matters, too, developments in measurement and monetary targeting may spare us from returning to a vertiginous wage-price spiral.

 

The other moral of Samuelson’s book is that sometimes ideas and policy objectives change in unexpected ways; sometimes leaders do rise to the occasion. He writes, “What was remarkable about the Volcker-Reagan policies is that they defied the standard political logic. All the adverse consequences (high unemployment, lost profits) were up front. All the benefits were indeterminate and lay in the hazy future.” He omits to mention the fortuitous timing. Thanks to events set in motion by Volcker, all the bad news came in the first two years of Reagan’s term as president.  He could afford to countenance strong measures against inflation.

 

The similarity to the situation facing Barack Obama is striking. It is true that the economy he inherits next year will be a poor one.  He must appear to make every effort to get things moving again.  And when they do begin to move, he will surely chafe against the speed limits imposed on growth by the Federal Reserve Board in order to avoid touching off another round of inflation.  But he can be fairly confident that the American economy will be showing robust growth by the end of his first term. Like Ronald Reagan, he can afford to take a longer view.

 

Thus the current speculation about the stimulus package, the bailout review and prospects for various changes in the income tax is plenty interesting and important, but these are vignettes within a larger story, subsidiary narratives unfolding against the backdrop of a  restructuring of the global financial system that has only just begun, portions of an intricate frame tale. The really interesting questions in these next two months have to do with the president-elect’s higher fiscal policy – the plans he formulates and the appointments he makes on environmental, energy, education and industrial policy.

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