Tuesday, April 15, 2014

Siding with Sumner

Scott Sumner:

Before we consider whether we are likely to repeat the mistakes of the 1960s era Fed, let’s review precisely what those mistakes actually were. Here’s the data as of November 1966:

Unemployment rate = 3.6%, and falling.

Inflation = 3.6% over previous 12 months. That’s a big increase from the 1.7% of the 12 months before that, and the 1.3% inflation rate two years previous. The “Great Inflation” began here.


Keep this data in mind when some fool tells you that the Great Inflation was caused by oil shocks or the Vietnam War or budget deficits or unions, or some other nonsense.

So let me add a little something to that. Sumner says it's not the Vietnam war that caused the inflation, and not Federal deficits. (He also says it's not the oil shocks of the 1970s that got inflation going in the 1960s. That can stand on its own, I think.) Here's a picture of the Federal deficits from 1950 to 1970. Bigger is higher on the graph:

Graph #1
The high point on the graph occurs in 1968, as the label indicates. Follow the blue line down to the left and you come to a low point just above the "5" in the "1965" on the horizontal axis. That low point is the Federal deficit in (you guessed it) 1965. A quarter-inch to the right of that you can see a kink in the blue line; that's 1966. Another quarter-inch to the right there is another kink, just below the horizontal line at the 10 level. That kink is 1967.

Now you can certainly say that the 1968 deficit was a big one, for the 20-year period we're looking at here. And you might say the 1967 deficit was a big one. But the deficits were small in 1965 and 1966; you can see that for yourself. Yet as Sumner points out, the rate of inflation was already climbing vigorously by 1966.

The Federal deficits did not cause the Great Inflation.

You know what I think: The rising cost of finance was the cost that started driving prices up, by the mid-1960s.

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