My previous posting, in response to the argument of Paul Krugman…
[H]ere’s the thing: the era of stagflation, at maximum, lasted from November 1973, when the first oil-shock recession began, to November 1982, when expansionary monetary policy worked exactly the way IS-LM analysis said it should. Long before those 9 years were up, we had proclamations that everything demand-side had been refuted by evidence.
There was hope that the Smithsonian currency alignment in December 1971 would work for some time. The U.S. dollar gained strength in the second half of 1972. Unfortunately, after a heavy speculative attack on the dollar it was suddenly devalued on 12 February 1973 for the second time after World War Two. This time, it was devalued by 10 percent, as the official price of gold was increased from US$38 per oz fine to US$42.22. Soon after the second devaluation, there was another heavy speculative attack on the dollar so much so that foreign exchange markets all over the world had to be closed from 2 March for seventeen days. When the exchange markets were reopened, the major currencies of the world including the US dollar, Deutsch Mark, Japanese Yen, Pound Sterling, French Franc, Dutch Guilder etc. were all floating. The world was now in a floating exchange rate system as a revolt against the IMF fixed exchange rate system.
…it is a historical fact Bretton went down between 2 March and 19 March 1973. But the economic wisdom that came out of the stagflation, particularly supply side economics is a total travesty.
How Did This Become Common Wisdom?
Cue Matthew Yglesias:
But the remarkable thing about the inflation of the 1970s is how long a span we went with key Federal Reserve officials insisting that curbing inflation expectations was beyond their power. And they invoked arguments you’ll be familiar with today. They thought there were major credibility and time-consistency problems. They thought money was already tight as evidenced by high interest rates so there was nothing more to be done. They noted, accurately, that the structure of the American economy was changing and then insisted, wrongly, that this somehow made it impossible or irrelevant for them to do their own jobs properly. People looked to high-profile politicians to provide solutions, and so high-profile politicians cooked up solutions. Gerald Ford wanted us to Whip Inflation Now largely through a campaign of exhortation.
|1969||4.40 %||4.68 %||5.25 %||5.52 %||5.51 %||5.48 %||5.44 %||5.71 %||5.70 %||5.67 %||5.93 %||6.20 %||5.46 %|
|1970||6.18 %||6.15 %||5.82 %||6.06 %||6.04 %||6.01 %||5.98 %||5.41 %||5.66 %||5.63 %||5.60 %||5.57 %||5.84 %|
|1971||5.29 %||5.00 %||4.71 %||4.16 %||4.40 %||4.64 %||4.36 %||4.62 %||4.08 %||3.81 %||3.28 %||3.27 %||4.30 %|
|1972||3.27 %||3.51 %||3.50 %||3.49 %||3.23 %||2.71 %||2.95 %||2.94 %||3.19 %||3.42 %||3.67 %||3.41 %||3.27 %|
|1973||3.65 %||3.87 %||4.59 %||5.06 %||5.53 %||6.00 %||5.73 %||7.38 %||7.36 %||7.80 %||8.25 %||8.71 %||6.16 %|
|1974||9.39 %||10.02 %||10.39 %||10.09 %||10.71 %||10.86 %||11.51 %||10.86 %||11.95 %||12.06 %||12.20 %||12.34 %||11.03 %|
|1975||11.80 %||11.23 %||10.25 %||10.21 %||9.47 %||9.39 %||9.72 %||8.60 %||7.91 %||7.44 %||7.38 %||6.94 %||9.20 %|
|1976||6.72 %||6.29 %||6.07 %||6.05 %||6.20 %||5.97 %||5.35 %||5.71 %||5.49 %||5.46 %||4.88 %||4.86 %||5.75 %|
The WIN jawboning was pretty darn effective, wasn’t it? Yglesias wasn’t alive while Ford was president and isn’t an economist, but he has access to basic economic data just as I do. Perhaps whacking his piece for the second time in two years isn’t sporting, but this is just unbelievably stupid:
When Paul Volcker came around and accepted responsibility for the problem, the adjustment turned out to be quite painful. But it wasn’t logistically difficult to pull off, it didn’t take very long, and all things considered we would have been a lot better off deflating in 1973-75 than waiting all the way until 1980-82.
OK, the terms disinflating and deflating might be hard to distinguish, but the first leads to the second, and Paul Volcker never triggered actual deflation:
|1976||6.72 %||6.29 %||6.07 %||6.05 %||6.20 %||5.97 %||5.35 %||5.71 %||5.49 %||5.46 %||4.88 %||4.86 %||5.75 %|
|1977||5.22 %||5.91 %||6.44 %||6.95 %||6.73 %||6.87 %||6.83 %||6.62 %||6.60 %||6.39 %||6.72 %||6.70 %||6.50 %|
|1978||6.84 %||6.43 %||6.55 %||6.50 %||6.97 %||7.41 %||7.70 %||7.84 %||8.31 %||8.93 %||8.89 %||9.02 %||7.62 %|
|1979||9.28 %||9.86 %||10.09 %||10.49 %||10.85 %||10.89 %||11.26 %||11.82 %||12.18 %||12.07 %||12.61 %||13.29 %||11.22 %|
|1980||13.91 %||14.18 %||14.76 %||14.73 %||14.41 %||14.38 %||13.13 %||12.87 %||12.60 %||12.77 %||12.65 %||12.52 %||13.58 %|
|1981||11.83 %||11.41 %||10.49 %||10.00 %||9.78 %||9.55 %||10.76 %||10.80 %||10.95 %||10.14 %||9.59 %||8.92 %||10.35 %|
|1982||8.39 %||7.62 %||6.78 %||6.51 %||6.68 %||7.06 %||6.44 %||5.85 %||5.04 %||5.14 %||4.59 %||3.83 %||6.16 %|
|1983||3.71 %||3.49 %||3.60 %||3.90 %||3.55 %||2.58 %||2.46 %||2.56 %||2.86 %||2.85 %||3.27 %||3.79 %||3.22 %|
|1984||4.19 %||4.60 %||4.80 %||4.56 %||4.23 %||4.22 %||4.20 %||4.29 %||4.27 %||4.26 %||4.05 %||3.95 %||4.30 %|
|1985||3.53 %||3.52 %||3.70 %||3.69 %||3.77 %||3.76 %||3.55 %||3.35 %||3.14 %||3.23 %||3.51 %||3.80 %||3.55 %|
|1986||3.89 %||3.11 %||2.26 %||1.59 %||1.49 %||1.77 %||1.58 %||1.57 %||1.75 %||1.47 %||1.28 %||1.10 %||1.91 %|
|1987||1.46 %||2.10 %||3.03 %||3.78 %||3.86 %||3.65 %||3.93 %||4.28 %||4.36 %||4.53 %||4.53 %||4.43 %||3.66 %|
Whether he knew it or not, Yglesias was entering the argument that a certain Federal Reserve Chairman that served from 1970 to 1978 was fully responsible for the 1970s stagflation. I’ve provided inflation, now unemployment:
Again, the excoriation of Arthur Burns makes no sense to me. His actions in 1972 only look foolhardy now because the 1970s “taught” economists that the NAIRU was probably in the 5.5-6.0% range, which both ignores the fact that the NAIRU from 1948-1970 typically was below 4.0% and the situation in 1976-77 where the NAIRU had become 7.5% and was rising fast.
Look at the data—once Carter took office inflation immediately started to rise, probably on account that he had defeated the author of Whip Inflation Now and wanted unemployment to come down. Carter appointed George William Miller to replace Burns in 1978, who definitely exposed dovish FOMC policy in the face of inflation rising above 11% before Volcker took over in August 1979. It was during this period the stagflation portmanteau came into vogue.
Blaming Carter For Acting Like A Republican
Economics in 1979 were enough to turn Carter into a whipping boy for the last 35 years, but the reality was the 39th president ushered in the era of deregulation:
Feb. 6 would have been Ronald Reagan’s 100th birthday. To honor him, this column celebrates that great champion of deregulation, that reinvigorator of the American economy, that believer in Adam Smith’s invisible hand: Jimmy Carter.
Yes, Carter. It was the peanut farmer from Georgia who pushed the United States toward a market economy, not the one-time actor from California. Reagan certainly shared Carter’s vision on deregulation, embracing with bravado policies that Carter launched with grim solemnity. But Carter laid the groundwork for the United States’ transformation from the economic malaise of the late 1970s to the vibrancy of the following decades. More importantly, only someone with impeccable credentials as a Democrat could have started deregulation. If it took Nixon to go to China, it took Carter to embrace markets.
His administration started with an industry that tries to turn a profit on turning jet fuel into noise…
Deregulation started with the airlines, where Carter-appointee Alfred Kahn told the public that the luxuries of that era’s air travel — roomy cabins, plush lounges, airline schwag and attractive young stewardesses — were products of exorbitant ticket prices that much of the public couldn’t afford. Deregulation would squeeze out those luxuries (unless the public really wanted them).
…companies that were so well run it ushered in an unprecedented wave of bankruptcies, which Matthew Yglesias conveniently blames on Carter regardless that nearly 200 occurred over a decade after Carter lost reelection. No matter, #39 was just getting warmed up:
Other deregulations followed: Kennedy’s younger brother Ted held a blockbuster Senate hearing on trucking that led to its deregulation. Rail freight followed suit. Carter’s administration began work on telecommunications deregulation, though the final breakup of AT&T and the beginning of long distance competition happened during the Reagan years. Congress enacted several banking reforms and competition forced local banks to branch out, offer more services and better interest rates, and stop working “banker’s hours.” Health care providers and insurers experimented with different coverage models. Energy companies had to become more efficient at extracting, refining and distributing their product.
I beg to differ on refineries, but continue Mr. Firey.
Not all deregulation met with public acclaim. Many consumers bristled at the rise of managed health care. Banking deregulation began only after many U.S. banks were on the edge of insolvency, and happened too late to avert the savings and loan crisis. Electricity deregulation initially brought lower rates, but prices later rose.
Still, consumers were the clear winners under Carter’s deregulations. Airfares fell by nearly 40 percent, in inflation-adjusted terms, from 1980 to 1996. Rail freight rates fell by 35 percent from 1985 to 2007, and rail productivity doubled. Trucking rates also fell, ushering in the era of “just-in-time” delivery.
All B.S. Just-in-time is a reckless system that spreads suppliers all over the globe rather than next door to final assembly, putting businesses at the mercy of global supply chains that daunt organizations the size of the U.S. military…and then puts it at the mercy of inclement weather. Who do we have to thank for all this?
Robert Samuelson uses his column today to tell readers that he is very unhappy with Paul Krugman. The specific complaint is that Krugman gives Paul Volcker credit for reducing inflation in the early 1980s, rather than Reagan. (Actually, I thought Krugman was giving Volcker credit for the recovery from the recession, which Krugman said was primarily due to lower Fed interest rates rather than Reagan tax cuts.)
Anyhow, Samuelson insists that Volcker has to share credit with Reagan, since Reagan gave him the political cover to carry through policies that pushed the unemployment rate to 10.8 percent and ruined millions of lives. I’m inclined to agree with Samuelson on this one. A different president might have put pressure on the Fed chair to back away before his policies had done so much damage.
Reagan and Volcker, the Team from…Well…
It might be worth pointing out that Volcker saw a significant rise in CPI after he released his foot in June 1981 when unemployment hit…7.5% (the same value that threw Burns off in December 1976). According to Dean Baker, the CPI increase and resulting “need” for a severe recession was a mirage:
Where Samuelson is wrong is in his characterization of the need for the Volcker policies. He tells readers:
“From 1960 to 1980, inflation — the general rise of retail prices — marched relentlessly upward. It went from 1.4 percent in 1960 to 5.9 percent in 1969 to 13.3 percent in 1979. The higher it rose, the more unpopular it became. People feared that their pay and savings wouldn’t keep pace with prices.
“Worse, government seemed powerless to defeat it.”
Actually, the inflation picture was not quite as bad as Samuelson describes. He apparently is referring to the measure using the official consumer price index (CPI), which had a well-known measurement error (more in a moment) that led to an exaggerated measure of inflation. In fact the inflation rate using the now popular consumer expenditure deflator peaked at just over 11 percent.
This graph is worth a careful examination. Note when the inflation rate began its long sharp decline. That’s right, it was in June of 1981, roughly six months before Volcker’s high interest rates threw the economy into a recession. This means that inflation was already falling rapidly when Volcker decided to make the tough call of throwing millions of ordinary workers out of their jobs.
Ouch. I explain later in this piece why I feel chained CPI also has its own issues. Regardless, Volcker was likely reacting to the CPI jump in June 1981, now only the 1982 recession was meaningless toward controlling inflation. There are two obvious explanations according to Mr. Baker:
The most obvious explanation for the drop in inflation is the drop in world oil prices. These had gone from less than $10 a barrel to 1978 to a peak over $40 a barrel in 1979, as Iran’s oil was pulled off world markets due to the Iranian revolution. In response to the surge in oil prices, new sources of oil came on line all over the world and people began to consume less, both in response to higher prices and government conservation measures (e.g. fuel mileage standards).
It definitely wasn’t the result of fixing the 40 year market failure, and I’m fearing the second explanation…
The drop in oil prices would have lowered inflation regardless of what Volcker did, although the recession undoubtedly did push down inflation further and faster than would have otherwise been the case. This was at the cost of a sharp drop in wages for most of the workforce and also the permanent loss of employment for many. Even a decade after the Volcker recession, employment among prime age men (ages 25-54) was still a full percentage point below the pre-recession level.
The other point about the inflation of the late 1970s is that it was in part driven by the measurement error in the official CPI. The CPI overstated the annual inflation rate by roughly 1-2 percentage points for several years in the late 1970s. This likely had consequences for the actual inflation rate since tens of millions of workers had contracts that linked their wages to the official CPI. This meant that errors in measurement would have been passed on in higher wages and generally then in higher prices. It is reasonable to believe that without this fluke in measurement, inflation would not have risen quite as much as it did during these years.
Anyhow, if Samuelson wants to Reagan to share the blame for an extremely painful recession, he will get no complaints from me.
See? Chained CPI makes the argument that measuring errors “accidentally” triggered a wage-price spiral in 1979-80. Considering the 1965-71 inflationary run-up is almost universally blamed on a wage-price spiral while the true culprits (Operations Rolling Thunder, Barrel Roll and the twin Cambodian abominations Operations Menu and Freedom Deal) are let off scot-free, I am a tad hostile to constantly looking for wage-price spirals.
This is a slight aside, but demand-pull inflation is strictly a supply problem (so is cost-push, and the non-recessionary solution below works just as effectively). Aggregate supply turns vertical in the short-term, not long term (the mathematical phenomenon is a result of capacity constraints, no sticky prices). The solution to “excess demand” is to increase SRAS (build more factories, farms, stores, etc.), not trigger senseless recessions like 1982. Too much money chasing too few goods means we need less money in the economy…or we need to produce more goods. You would think this would have been a solution proposed by “supply-side economists”…
Dean Baker doesn’t have an explanation for one aspect of the Reagan/Volcker economic disaster. How did inflation get crushed down to 1.10% at the end of 1986? Why did the disinflation continue after Volcker loosened monetary policy in 1983? I have to answer with another question: why does the wage-price spiral have such staying power when it is largely a mirage?
05 August 1981
I have strongly argued (hopefully convincingly) the 1970s stagflation began on 19 March 1973…and ended the day Ronald Reagan crushed the PATCO strike. Earlier this month we mentioned the lies surrounding this ignoble episode; it exposed the 40th president as the craven backstabber he truly was:
On October 20, 1980, then Republican nominee for president Ronald Reagan wrote what is in retrospect a deeply ironic letter asking PATCO for its endorsement. In the letter, he stated that he deplored controllers “working unreasonable hours,” promised to “take whatever steps are necessary to provide our air traffic controllers with the most modern equipment available,” and pledged to “adjust staff levels and work days so that they are consummate with achieving a maximum degree of public safety.” Thoroughly unhappy with President Carter’s economic performance and impressed by Reagan’s union background, PATCO gave the former president of the Screen Actors Guild its unequivocal endorsement.
PATCO began contract negotiations with the FAA upon Reagan’s election. The air traffic controllers’ primary demands were an across the board $10,000 pay increase, a $15,000 increase in their maximum potential salary, a cost of living increase 1.5 times the rate of inflation, and a 8 hour reduction in their work week (from 40 to 32 hours). The FAA was frustrated with PATCO’s increasing demands over the past years, and they were particularly incensed by these significant stipulations. Other government officials agreed with the FAA—one Office of Management and Budget report called air traffic controllers “the most overpaid, pampered employees in the Nation.” Still, the FAA did not want a strike, and therefore offered the controllers a significant and unheard of concession: a 5% across the board salary increase, along with several other “sweeteners” such as total exemption from overtime pay and paid lunch. Such a proposal was unprecedented in negotiations with the federal government, and PATCO President Robert Poli discussed it with the union’s leadership. The air traffic controllers, angered by what the perceived as Reagan reneging on his earlier promises as a candidate and emboldened by both their generally positive track record with militant action and ability to disrupt global air traffic, voted to initiate a nationwide strike. On the morning of August 5, 1981, just as Poli had once memorably threatened, American skies fell silent.
But beyond the 11,000 he victimized, #40 indirectly stabbed us all:
Historian and labor activist Stanley Aronwitz has argued that PATCO’s inability to “contest, let alone command, the public discourse” allowed President Reagan “to set the discursive agenda for the conduct of the strike.” These discourses influenced corporate America far beyond 1981, and changed the way in which it understood its relationship with labor. I posit that the conclusion of the PATCO strike created and perpetuated notions of labor as a commodity that can easily be replaced in corporate America. Specifically, President Reagan implicitly endorsed and normalized the use of permanent replacement workers—which allow an employer to terminate the employment of its entire workforce and hire new workers if it pleases. This process circumvents contract negotiations entirely, as the old contracts are voided once the workers are fired and the employer is not required to negotiate a new agreement. Indeed, Reagan did exactly this during the PATCO strike: he fired approximately 80% of all civilian air traffic controllers in the United States, banned them from federal employment, and initiated the process to replace them. Jeremy Brecher has argued that the practice of employing permanently replaceable workers was “virtually unknown in the U.S. [between] the institutionalization of labor law in the 1940” and the 1980s. The effect of the President of the United States himself indiscriminately replacing union workers, irrespective of their skills, cannot be understated. It encouraged corporate America to accept the notion that permanent replacement was an acceptable recourse when workers initiated a strike.
Donald J. Devine, a Reagan Administration official who at the time of the strike was the director of the U.S. Office of Personnel Management, has argued emphatically that the PATCO strike gave “American business leaders…a lesson in managerial leadership that they could not and did not ignore.” He also stated that private sector executives personally informed him that “they were able to cut the fat from their organizations and adopt more competitive work practices because of what the government did [during the strike].” Devine does not detail these practices, but it can be inferred by tracing the broader trends in labor relations at the time that he is at least in part referring to the use of permanent replacement. Clinton Secretary of Labor Robert Reich noted in Congressional testimony “that employer willingness to hire permanent striker replacements seriously hampered cooperation between labor and management.” He specifically pointed to the practice of corporations advertising for permanent replacements even before negotiations begin, which he likened to the “stockpiling [of]…raw materials”—a clear reference to the commoditization of labor.
PATCO marked the rise of 1099 America—the worker became the contractor. Companies have been turning away from both permanent and temporary employment to screw employment (why hire a temp agency when workers will hire themselves out for less pay directly); in effect the U.S. has become a nation of lowest bidders. Any pretense that wages and productivity are linked has steadily fallen to the wayside, a relic of a bygone (pre-1981) era.
Back to Paul Krugman’s argument:
[H]ere’s the thing: the era of stagflation, at maximum, lasted from November 1973, when the first oil-shock recession began, to November 1982, when expansionary monetary policy worked exactly the way IS-LM analysis said it should.
Did it? Let’s explore this a little more. Since 1981-82, interest rates have had one trajectory…down. So far, so good. For 17-18 years, loosened monetary policy worked wonders, especially in the second half of the 1990s:
In 1995 and 1996 he lowered interest rates and kept them low. This allowed the unemployment rate to fall below the 6.0 percent level…. The decision to allow the unemployment rate to fall to levels that most economists thought would trigger inflation gave millions of people jobs…. The tight labor market of the late nineties allowed for the first sustained growth in real wages for most of the country’s workers since the early seventies. We will benefit from this decision for years to come… the country benefited hugely because [of] Alan Greenspan..
But there is a problem. Contrary to the assertion loose monetary policy will trigger inflation, Greenspan effectively brought the U.S. to the zero-lower-bound five years “ahead of schedule” (before the ZLB actually brought 0% FF rates):
The Fed seemed to take notice of the weakness of the economy keeping the federal funds rate at just 1.0 percent until the summer of 2004. This can be seen as effectively the zero lower bound. No one thinks that there is any great stimulatory effect from dropping the rate from 1.0 percent to zero, which is why people routinely talked about the European Central Bank as being at its zero lower bound even when its overnight interest rate was 1.0 percent.
Of course even when the economy did finally bounce back it was on the back of the housing bubble, which was not a very stable course.
That’s one way of putting it. The other is Greenspan became so uncomfortable with the prospect of the zero-lower-bound perpetuating he pushed for raising the federal funds rate from 2004 until Bernanke was faced with the 2008 crisis, leaving the U.S. with job growth running at one-third (at best) the rate of the previous five decades…before the Great Recession wiped out everything.
Except it really didn’t–the U.S. had been wiped out for eight years already. The United States has been at the actual ZLB since before Obama took office, but effectively the country hit it in 2000. The ZLB has dominated the entirety of the 21st century. The trajectory is unmistakable if you begin from Volcker in the 1980s–straight down. Even stranger, IS-LM predicted the arrival of the ZLB.
Shifting LM to the right has an very obvious limit–i cannot drop below 0. So if LM is wiped out, we need IS to start moving, right? IS shifts right, LM moves i back to 0, and we start all over again. IS-LM predicts the ZLB will perpetuate indefinitely. But this cannot be right, can it? Interest rates have to rise…except why do they have to?
Really, why would economic analysis assume interest rates must rise? It’s not from any modeling; I just demonstrated the ZLB could be perpetuated indefinitely. The reason economics insists interest rates must rise is half historical and half logical. 0% interest seems to have all sorts of issues, mostly centered on moral hazard. We can discard most of them, because raising interest rates for the sake of morality merely induces an economic recession senselessly. Hey this is starting to sound like Paul Volcker, 1981.
REALLY Rethinking IS-LM
OK, investment-saving (IS) and liquidity preference-money supply (LM). Undeniably Keynesian, which is odd considering the action is exclusively on the supply side. Think about it: IS builds infrastructure–including houses, stores, gas stations, factories and farms beyond the obvious. In a word, it expands SRAS. LM works almost exclusively through the financial markets, and who does the financial industry prefer to invest in? Other businesses, the bigger the better. In other words, IS that builds infrastructure that expands SRAS.
The problem is all the action starts with demand, which ALWAYS gets short shrift. Not just from supply-side economics mind you; Keynesian economics relies on a model that simply is better at the supply side than those that are self-styled. I’ve written too extensively about this to even scratch the surface in this already-too-long posting (I entitled every post on the subject Aggregate Demand Dominance if needed), but in essence shifting AD drives up both real GDP and the price level, which interest rates are ultimately a financial measurement of.
There are two ways to contain this inflation: steady SRAS expansion (which is rarely attempted except accidentally or as part of a concerted war effort) and demand suppression. Demand suppression has been in vogue for centuries; leading to the gold standard and more direct price controls. The price controls enacted since 1981 are particularly brutal: straight up wage suppression, enforced by transforming the economy into 1099 America. This suppression drives inflation into the floor, with a corresponding drop in potential GDP growth. In two words, secular stagnation.
Secular stagnation has become such a concern Chicago-school economists might not dismiss it as out-of-hand in the near future. This article meant to argue, amongst the historical ramifications, that wage suppression is the greatest calamity in our time. How do we address it? Can we address it, considering the power accumulated in those few that “bargain” with the many that live paycheck-to-paycheck?
Yes. The power accumulated in the hands of the American oligarchs is dependent on one major change that occurred in 1985; a change that has reversed itself, perhaps permanently.