Friday, September 27, 2013

Hetzel (1998) on Burns

From Arthur Burns and Inflation (PDF) by Robert L. Hetzel:
In November 1970, the minutes of the Board of Governors show Burns telling the Board (Board Minutes, 11/6/70, pp. 3115–17) that

prospects were dim for any easing of the cost-push inflation generated by
union demands.

In 1970, Arthur Burns attributed inflation to union wage demands.

One page later, Hetzel presents a more tangled tale:
How did Burns view macroeconomic policy as an economist? Most generally, Burns had a credit view of monetary policy. That is, monetary policy worked through its influence on the credit market. However, monetary policy was only one factor affecting credit markets. At times, in its influence on inflation, monetary policy could be overwhelmed by other factors. More specifically, Burns had a real or nonmonetary view of inflation. That is, inflation could arise from a variety of sources other than just money. He believed that a central bank could cause inflation by monetizing government deficits but did not attribute inflation to that source in the early 1970s. Instead, he attributed it to the exercise of monopoly power by unions and large corporations.

If conventional monetary policy weapons were powerless to deal with these forces, then perhaps direct controls might work. Accordingly, President Nixon imposed wage and price controls August 15, 1971. The experience with such constraints offered a tailor-made experiment of Burns’s views. The controls worked as intended in that they held down wage growth and the price increases of large corporations (see Kosters [1975]). Nevertheless, inflation rose to double digits by the end of 1973. So Burns attributed inflation to special factors, such as increases in food prices due to poor harvests and in oil prices due to the restriction of oil production. However, special factors are by nature one-time events. In 1974, inflation should have fallen as the effect of these one-time events dissipated, but it remained at double-digit levels that year. Burns then blamed inflation on government deficits. Although those deficits were small in 1973 and 1974, Burns was able to make them look larger by adding in the lending of government-sponsored enterprises like the Federal National Mortgage Association.

Burns said inflation was caused by wage demands. Wage and price controls worked as intended but inflation rose anyway. Then Burns changed his story and blamed special factors. But the special factors passed, and time went by, and inflation did not fall. So Burns changed his story again and blamed government deficits, even padding them to make them look bigger.

That's not my story. It's Robert Hetzel's, and it isn't kind to Arthur Burns. I don't know if the story's accurate. I know that other parts of Hetzel's PDF agree with things I hold true, things I read long ago, things written in the 1970s. Such old sources seem to me less tainted by modern views, and more reliable. And Robert Hetzel's story fits well with those.

Here is what I want to say:

Burns covers all the bases, all but one. He points the finger at workers. He points the finger at acts of God. And he points the finger at government. But he does not point a finger at finance, the rising cost of finance.

Maybe I'm wrong. Maybe the cost of finance is not the cost that's killing us. But we cannot possibly know that, if we refuse to look at it.


The Arthurian said...

In comments on Josh Hendrickson's Nominal Income and the Great Moderation, Nick Rowe wrote:

"People forget (and maybe younger people never knew) just how common that view was in the 1970′s. It was common among economists as well as the general population. It was almost the orthodoxy of the time, IIRC. Tighter monetary policy would just raise interest rates, which would increase costs, and make inflation even worse."

(Emphasis added.)

Bill Woolsey replied:
"There were really _economists_ who thought that “tighter money” would raise inflation through a cost-push mechanism?"

I quoted Robert V.Roosa from 1971 and Scott Sumner from 2013, both of whom say raising interest rates is inflationary. Here's Sumner:

"Higher interest rates are inflationary. Repeat 100 times. But the thing the Fed uses to generate higher short term interest rates—a reduction in the money growth rate—is deflationary."

If Sumner is right about this, as I think, then we would have to put weights on the two factors to see whether a given increase of interest rates would push prices up or pull them down.

The weight factor we apply to interest rates would surely be related to the level of accumulated debt. When there is little debt, the increased cost of interest adds little to the upward pressure on prices. But when there is much debt, the increasing interest cost adds much to the upward pressure on prices.

You cannot look at a low-debt economy and draw conclusions that dependably apply to a high-debt economy.

Jazzbumpa said...

If raising interest rates causes inflation, then rates should lead CPI. That might be true in 69-70 and 73-4, but not by much.

That's awfully fast reaction, at a time when there's a lot of other stuff going on.

I don't think you can make that case at all, post 76.

I must admit, this is a new concept for me, and I have to struggle hard against ad hominum whenever Sumner is involved.

OTOH, Burn's continuous goal post migrations do lend some credence to the idea that he was inept.


Jazzbumpa said...

Sumner, quoted by you at the Hendrickson Post:

"Let me repeat, higher interest rates are inflationary. They increase velocity. If you don’t believe me, check out interest rates and velocity during any extremely high inflation episode. When rates rise, inflation usually rises. Higher interest rates are inflationary."

The claim regarding velocity seems totally specious.

On the rise, motion is, at best concurrent. On the decline, CPI clearly leads MZM velocity. [I multiplied by .6 to get a better vertical line up.]

What am I missing?


The Arthurian said...

Hi Jazz. Cost. I think you are missing cost, the cost of finance.

(The following remarks are in response to the earlier of your two comments here.)

Good graphs! I accept your evaluation: Raising interest rates was probably not the cause of the Great Inflation. Surely if the Fed reacted to inflation by raising rates, then the inflation came first.

Still, it is easy to admit that the increasing financial costs resulting from higher rates would have contributed to inflation. Where Sumner has written "Higher interest rates are inflationary" (and you read it as "raising interest rates causes inflation") I read it as higher interest rates increase costs and put additional upward pressure on wages and prices.

Now, imagine the moment when our economy was golden, and inflation was at its early-1960s low of 1% annual. The baby boom kids were too young to be in the workforce. Oil was still cheap. The Viet Nam war was in its infancy. None of these factors was driving inflation. But private nonfinancial debt was growing at a rate of 8 to 10% per year. And so were financial costs -- even apart from interest rates, which were already rising.

But even if interest rates had been stable, the growth of debt would have assured the growth of financial cost, creating the cost-push pressure that Arthur Burns incorrectly attributed in turn to wages and profits, and oil and weather, and Federal deficits.


Regarding Sumner... Scott Sumner is the leader of a band of economists who call themselves "market monetarsts". Among those in this merry band are Nick Rowe, Josh Hendrickson, Marcus Nunes, and I think Bill Woolsey. NR and JH dismiss the thought that financial costs contribute to inflation, and Woolsey seems unaware of it.

And their leader Sumner contradicts them all!

Jazzbumpa said...

Off to Toledo or the day. I'll give this more thought in the next couple of days.


geerussell said...

I have to struggle hard against ad hominum whenever Sumner is involved

Ha, I thought it was just me that felt that way.