How Inflation Whipped Us

__"Arthur Burns and Inflation" by Robert L. Hetzel, in Economic Quarterly (Winter 1998), Federal Reserve Bank of Richmond, P.O. Box 27622, Richmond, Va. 23261.__

During the early 1970s, Federal Reserve approach he favored to fight it boomeranged, Board chairman Arthur Burns was the very writes Hetzel, vice president of the Federal symbol of opposition to inflation. But the Reserve Bank of Richmond, and that failure led to today’s very different consensus on how to keep the dollar sound.

Burns, a distinguished economist who began his term as Fed chairman in 1970 and had previously chaired President Dwight D. Eisenhower’s Council of Economic Advisers, did not believe that the Federal Reserve, by regulating the supply of money, could do very much to control inflation. Monetary policy influenced interest rates, and that might well affect the confidence of businessmen and their willingness to invest. But otherwise, monetary policy was of scant value, in his view, which was also the conventional wisdom of the day. Monetarist economists such as Milton Friedman, who believed that controlling inflation meant regulating the money supply, were then in a minority. Keynesian economists, who wanted to use the federal taxing and spending powers to keep the jobless rate down and the economy booming, represented the mainstream.

Although not a Keynesian, Burns accepted the general view that it was government’s responsibility to keep the unemployment rate down to four percent or less, Hetzel says. As for inflation, Burns believed that it has many different causes, and that the most important in the early 1970s was excessive wage gains, stemming from the monopoly power of labor unions. When the jobless rate climbed to six percent in 1970, Hetzel says, Burns believed that the government had to act to "simultaneously restore price stability and full employment." Burns cheered when President Richard M. Nixon imposed wage and price controls on August 15, 1971.

"Controls did everything they were supposed to do," writes Hetzel, "except prevent a rise in inflation." When inflation registered in the double digits in 1973, Burns blamed a variety of special factors, especially a combination of a strong economy and shortages of oil, farm products, and other commodities. As these factors changed, he believed, inflation would decline.

Instead, inflation stayed in double-digit territory. Burns then lobbied hard for a continuation of wage and price controls, but Congress had had enough, and key figures in the new Ford administration—Alan Greenspan, chairman of the President’s Council of Economic Advisers, and William Simon, secretary of the treasury—were opposed. Burns, who continued as Federal Reserve chairman through 1977, "then blamed inflation on government deficits," Hetzel notes, but the fact was that those deficits were very small in the high-inflation years of 1973 and 1974.

"For Burns, the source of inflation changed regularly," Hetzel writes. Because he had no economic model to be tested by experience, he could not, in a sense, learn from experience. But others did learn. The consensus today is that inflation is a monetary phenomenon, Hetzel notes. "The central bank is the cause of inflation"—and controlling it is the Federal Reserve’s paramount responsibility.