What’s currently driving our economic crisis is confidence and expectations – both psychological components that are often overlooked by politicians and even economists. It’s precisely these psychological – even spiritual – matters that affect our ability to respond to crisis. And Robert Samuelson has apparently done us a great service by highlighting psychology particularly as it relates to the issue of inflation – the pernicious phenomenon that plagued us from the mid-1960s to the 1980s. I plan to read The Great Inflation and Its Aftermath: The Past and Future of American Affluence forthwith.
But until I do, I leave you with Dane Stangler’s fine review in City Journal. And in Stangler’s words, the problem was the prideful men who thought they’d mastered the economy and could fine tune it at will. When matters went badly awry, they continued to apply their ‘mastery’ even as they were proven wrong:
That is, until the economy itself intervened. The long postwar expansion crashed and burned in the 1970s. Recessions in 1969–1970, 1973–1975, and 1980 should have undermined the “new economics,” but they only drove economists and policymakers to do more of the same. Richard Nixon pushed full employment as his top economic goal and, in a political game of chicken with Democrats, imposed disastrous wage and price controls. Gerald Ford actually made some effort to address inflation, but the Carter administration, in an almost unbelievable escalation of error, continued to make the same mistakes.
Fiscal and monetary policy had become inverted in importance: most of the economists advising Kennedy and Johnson “regarded Federal Reserve policy . . . as playing a subordinate and supporting role” to fiscal policy. A gradual move away from the dollar-gold standard, culminating in Nixon’s final repudiation of the Bretton-Woods system in 1971, had the unseen effect of loosening limits on credit creation and expansion: “Inflation would no longer control itself. It had to be controlled—and so the ideas, beliefs, motives and behaviors of people charged with controlling it mattered,” Samuelson writes. Unfortunately, those people—officials at the Federal Reserve—became swept up in the all-out push to full employment.
Even after Milton Friedman’s ground-breaking research showed inflation to be a monetary phenomenon, the old cures were still applied: “even after years of rising prices throughout the economy, G. William Miller, who served a brief stint as Fed chairman under Carter, still warned about the ‘limitations of monetary policy as the main bulwark against inflation.’”
But the inflationary spiral was only broken by a new set of ideas and an emphasis on psychology – applied by Ronald Reagan and Paul Volcker.
Samuelson places great emphasis on psychology, an aspect of Keynes’s work that many Keynesians in the 1960s ignored. Reagan and Volcker succeeded because they attacked the expectations that are the most damaging consequence of inflation. Their efforts had little to do with abstract theory or political dealmaking; Volcker and Reagan, never close, instead formed a “compact of conviction.” Enduring the harshest recession since World War II and the general opprobrium of politicians and business owners, Volcker embarked on a new course (regulating the money supply, not interest rates) and Reagan provided political cover.
Samuelson’s story, then, turns on human tendencies and considerations that Euripides and Sophocles would have readily recognized: “Political ideas often follow the familiar cycle of infatuation and disenchantment. . . . So it was with the pledge to abolish business cycles.” Hubris and overreach, followed by fear and timidity. Inflation receded not because of superhuman acts of brilliance, but through human virtues often lacking in democratic leaders: patience, perseverance, and courage.
And as we watch the hubris on display in our own time, let’s hope that there are still virtuous men and women in positions of responsibility who have the patience, perseverance and courage to endure general opprobrium – and do the right thing.
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