POLICY ACTIONS 1978–79
As mentioned, the administration decided at its inception that it did not favor use of monetary and fiscal policy to reduce inflation. The cost in higher unemployment and lost output seemed too great. Instead it proposed voluntary wage-price moderation as part of its April 1977 program.94 Schultze later said, “We had an anti-inflation program, so-called, in April 1977 . . . none of which meant anything” (quoted in Biven, 2002, 134). By the time Miller took office, inflation had increased and the program was dead. The administration blamed increases on food prices. Real wages rose slowly, but productivity slowed even more, so unit labor costs rose more than 8 percent in the year ending first quarter 1977 (memo, Schultze to Carter, Carter Library, Box 194, May 11, 1977).
94. The program included extension for two years of the Council on Wage and Price Stability (COWPS), which had administered President Nixon’s wage and price controls. Also, the program called for deregulation of communications, trucking, and other industries. This was one of the more successful economic initiatives taken during the Carter presidency. While governor of Georgia, Carter had listened to a Georgia economist who now advised him that jawboning and guidelines would not work, so he was not surprised that guidelines failed.
At his first FOMC meeting, March 21, 1978, Miller told the members:
We have all these policy dilemmas we are speaking about. Relative growth rates are such that we are going to have these large current account deficits. Then our choices are going to narrow down to whether we’ll take a lower growth rate in our economy because it doesn’t look like we are getting the relative speedings in other economies. [A lower growth rate] is something that I think many of the economic advisers in the Administration are now willing to accept because the alternative is to see the dollar under pressure and our resources to change it are not great. And that in itself feeds inflation into our economy and creates a whole series of other [developments] that lead us down an unhappy trail. (FOMC Minutes, March 21, 1978, 9)
Governor Partee expressed “amazement” that the administration would favor a lower growth rate. President Eastburn (Philadelphia) suggested that a recession might be needed. Wallich insisted on the need to reduce inflation. No one pointed out that lower growth during a recession would produce mainly a temporary reduction in current account balances. The effect on the exchange rate was uncertain.
In April 1978, Blumenthal and Schultze sent a memo on inflation that began on an ominous note. “During the past several months, a growing concern has developed around the country about the outlook for inflation. Your April 11 announcement of steps to implement the anti-inflation program was an important step in dealing with the inflation problem. Realistically, however, the chances are no better than 50–50 that the anti-inflation program will lead to significant moderation of wage and price increases— even if it is followed up vigorously and continuously” (memo, Schultze and Blumenthal to the president, Schultze papers, Carter Library, April 13, 1978).95 A memo to Vice President Mondale reported adverse polling data. The president’s rating on managing the economy had fallen from 47 percent to 24 percent. “Moreover, other recent polls show a dramatic shift in public concern over inflation as opposed to unemployment” (quoted in Biven, 2002, 137). This proved to be a step on the path to monetary restraint.
The Carter administration was incapable of devising a successful strategy for reducing inflation. Labor unions, an important support group, opposed both wage controls and guidelines and higher interest rates. Business groups would accept price guidelines only if unions accepted wage restrictions. That would have been a program, but inflation can be hidden but not ended by such means. The administration wanted tax reduction, not an increase, in 1978. And it opposed raising interest rates enough to slow inflation. Its efforts consisted of cosmetic actions and the hope that they might succeed. Unfortunately for them, public opinion now saw inflation as a major problem.96 Schultze (2005) recognized the problem, hoped to enforce the guidelines with greater effort, but he recognized that other effective actions had been ruled out by concern to avoid increasing unemployment.
95. The new program followed the program outlined in the 1978 Economic Report. Voluntary steps to decelerate wages and prices sector by sector, reductions in government wage increases to set an example, etc. Robert Strauss, a persuasive Texas lawyer, became counselor on inflation to persuade business and labor. Large corporations offered cooperation. The AFL-CIO did not (Biven, 2002, 137–38). And the coal miners negotiated a three-year 38 percent increase in wages at this time.
The choice of Miller added to the problem of controlling inflation. George Meany, president of the AFL-CIO, wrote the president quoting and endorsing Miller’s approach enunciated in a 1974 interview.
Working our way out of inflation requires an allocation of the available but limited resources to areas of priority, thus reestablishing a proper balance between supply and demand. Allocation solely by controlling the aggregates— the supply of money and net federal spending—will bring about levels of unemployment and general economic hardship that are likely to be unacceptable. Allocation by direct controls involves even more difficulties. (letter, George Meany to the president, Schultze papers, Carter Library, May 19, 1978)
Meany added that Miller saw the need for a new approach, mainly selective controls including credit controls. He agreed. President Carter later requested the Federal Reserve to impose such controls.
Miller had apparently changed his mind. In his first press interview he explained that the Federal Reserve must achieve “a gradual slowdown in the expansion of the money supply” (Rowe, 1978). Miller also supported the president’s program to moderate price and wage changes. And he recognized that shifting from unemployment to inflation would not achieve both objectives. “Society can not reach the goals of full employment growth and price stability independently” (ibid., D10).97
96. An example is a fourteen-page memo to the president signed by Schultze and Blumenthal dated April 13, 1978. Near the end of the memo, a White House staff member wrote about the recommendations. “This is an anti-climax . . . they say don’t do anything. This is absurd” (memo, Schultze and Blumenthal to the president, Schultze papers, Carter Library, April 13, 1978, 14).
97. On his last day at the Federal Reserve, Arthur Burns spoke about inflation and the dollar. He favored pay cuts for government employees, an energy conservation policy, and tax cuts to increase investment. He also favored “massive intervention” to strengthen the dollar, supported by sales of gold, SDRs, and $10 billion of bonds denominated in foreign currencies (Rowan, 1978, A2). Burns placed greater importance on avoiding currency depreciation than on curtailing domestic inflation. In November, the administration adopted several of his proposals.
The Federal Reserve began to raise the federal funds rate in May 1978.98 The monthly average rate rose from 6.9 to about 10 percent that year. At the time, the FOMC set annual growth rates for the monetary aggregates and two-month average growth rates for M1 and M2. It specified a federal funds rate believed compatible with the money growth rates. If a discrepancy arose, the committee held a telephone meeting to assess the situation. During 1978, the planned two-month money growth rates changed very little. Actual M1 growth reported in the minutes rose as high as 19 percent (April), 11 percent (August), and 14 percent (September) without any decisive effect on FOMC actions. Most of the time M1 and M2 desired growth rates were 4 to 8 or 9 percent and 5 to 9 or 6 to 10 percent respectively. Table 7.12 shows the monthly average federal funds and monthly CPI inflation rates during Miller’s term as chairman. Average federal funds rates were, as before, very close to policy rates specified by the FOMC.99
98. The minutes obtained from Burns’s papers end when he left the Federal Reserve in March 1978. For the rest of 1978, we relied on the Annual Report supplemented by the minutes for May to December 1978 that Debby Danker made a special effort to edit and release in 2007. We greatly appreciate her effort.
99. At the April meeting, the FOMC had an active discussion of a proposal by President Baughman (Dallas) that the FOMC announce a three-year target for money growth. Only Roos (St. Louis) supported him. The Subcommittee on the Directive opposed because they said no one would believe that they would achieve the three-year growth rate. Baughman argued that the FOMC needed to meet long-term objectives, but he argued in vain. In 2007, the Federal Reserve adopted the proposal as part of a plan to become more transparent.
In Table 7.12, the measure of the real interest rate, ex post, is positive in only three months, August, November, and December 1978. The inflation data include the one-time price level increase from the oil price shock. Usually the FOMC did not distinguish this transitory effect on inflation, and neither did the administration. Wage increases are another measure of inflation; in April 1978 wages rose 8.3 above the previous April. In 1977, wages increased 7 percent from 1976.
In fact, the Council of Economic Advisers and the Secretary of the Treasury took the highly unusual step in June 1978 of meeting with the Board of Governors out of concern about the increase in interest rates that occurred in the spring. At the time, the ex post real federal funds rate was −4.8 percent.100
Schultze explained to the president that “the Board is very concerned about inflation. Some members of the Board appear to be prepared to tighten monetary conditions still further; . . . [T]hey seem willing to run some risks with tight money because of their inflation worries—Chairman Miller is under considerable pressure from some of the more vocal and articulate inflation-fighters on the Board. He, himself, is very sensitive to the danger of overdoing monetary restraints” (memo, Schultze to the president, Schultze papers, Carter Library, June 27, 1978).101
In the rest of the memo, Schultze spelled out his forecast for the economy for the next eighteen months. He expected real growth of 3.75 to 4 percent with productivity growth only 1 percent. This was slower growth than in early 1978. Schultze estimated that the underlying rate of inflation, excluding food and mortgage costs, was between 6 and 6.5 percent. Unit labor costs would rise 7 percent in the next year. He explained that his forecast assumed that M 1 would rise more than the 4 to 6.5 percent annual target and that Congress would approve a $20 billion tax cut, effective January 1.102
100. Schultze had become more concerned about inflation. Early in May, he told the president about his concern and the need to tighten the 1979 and 1980 budgets. The president wrote on his memo: “A new Convert” (memo, Schultze to the president, Carter Library, May 8, 1978, 2).
101. Lyle Gramley attended the June 19 meeting at the Board. “I had some notion before we went that this was not the appropriate thing to do. It would be quite unproductive. And it was. If anything it may well have been counterproductive” (Biven, 2002, 141). Schultze had warned the president about interest rate increases in April. He thought they were appropriate. His concern was that they would continue too long and increase too much.
102. In late May President Carter reduced the proposed tax cut by $5 billion (to $20 billion) and postponed its effective date to January as an anti-inflation measure. He also requested some small spending cuts.
Schultze’s memo indicated concern about additional interest rate increases. He suggested that the president discuss this with Miller at the Quadriad meeting the following day. Charts accompanying the memo showed growth of M 1 well above the 6.5 percent maximum target. Eizenstat was not persuaded. He told the president that the president’s policies can “help avoid inflationary actions.” The private sector was responsible for lowering inflation (Carter papers, May 9, 1978).
A quick reading of the April 18 FOMC minutes would suggest a major division over inflation policy. Verbal disagreements were sharp. But almost all proposals for M 1 growth called either for 4 to 8 or 5 to 9 percent. Similarly, all but one proposal called for either a 6.5 to 7.5 or 6.75 to 7.25 funds rate. The vote called for 6.75 to 7.5 with a conference call if the rate reached 7.25 percent. Within three weeks, the April–May money growth rate reached 13 percent, and the Board staff raised nominal GNP growth to 17 percent in the second quarter.
Chairman Miller described monetary policy as “prudent and decisive” (FOMC Minutes, May 5, 1978, 4). He thought the projected second-quarter GNP growth might be transitory, so he favored leaving the fund rate at 7.25. Ignoring years of delay, he said action would suggest that the committee was “too quick on the trigger” (ibid.). He favored a 0.5 increase in the discount rate the following week. Only Black, Willes, and Wallich favored an increase in the funds rate but only Black and Willes voted against Chairman Miller’s recommendation. Once again, some of the reserve banks were most willing to act.
Although the administration adjusted its anti-inflation actions several times, Schultze did not expect much effect. His forecasts in May 1978 showed inflation unchanged for the next four years at about 6.5 percent. The unemployment rate forecast suggested that unemployment would remain about 5.5 percent. In the critical political year 1980, forecast inflation and unemployment rates were 6.7 and 5.4 to 5.7 percent respectively (Schultze to the president, Carter papers, Box A8013, May 13, 1978, 5).103 Soon after he wrote that worsening inflation required giving inflation control a higher priority. But he opposed fighting inflation with monetary and fiscal policies alone. “Our best hope of getting inflation under control lies in a joint effort by businesses, labor and government to achieve deceleration in the rate of price and wage increases” (draft letter to George Meany, ibid., May 31, 1978).
103. In an interview, Carter said that he believed the economy would be in good shape in October 1980, based on projections received from Schultze and William Miller in May. He expected inflation to decline by 5 or 6 percentage points and the unemployment rate to fall also (Carter, 1982, 59).
Much more than in the past, FOMC members accepted that inflation was mainly a monetary problem. As Orphanides (2001 and elsewhere) emphasized, the level of the so-called natural rate of unemployment used to forecast inflation was uncertain. At the May 1978 meeting, the staff characterized the natural rate as difficult to estimate (FOMC Minutes, May 16, 1978, 6). Their estimate was 5.5 to 6 percent, far higher then the 4 percent rate used for many years. The members did not agree. Wallich thought 5.5 percent too low; Partee thought it too high. The disagreement shows a major reason for low reliability of inflation forecasts based on a Phillips curve.
Coldwell, Balles, and several others agreed with Wallich and urged the committee to slow the economy (ibid., 13–15). Jackson spoke about “a loss of public confidence . . . [that] will damage the economy” (ibid., 33). But Eastburn and Partee remained “pessimistic” about inflation. Partee added that a 1979 recession was now likely (ibid., 18). Axilrod cited some staff work showing that M 1 was a good indicator of future GNP. The divisions within the FOMC remained for the rest of the year, preventing effective anti-inflation actions.
At the June meeting, Chairman Miller proposed a moderate program of disinflation. “If we use a steady and sure hand to restrain the growth of the aggregates and bring it down at a more measured pace, then I think we see conditions for bringing the rate of growth down to a more sustainable level that will counter inflation but avoid . . . recession” (ibid., June 20, 1978, 18). Regrettably, he did not institute procedures to carry out his program.
The FOMC voted for an increase in the funds rate to the 7.5–8 percent range at the June meeting to recognize growing public and administration concern about inflation. Mark Willes (Minneapolis) and Willis Winn (Cleveland) dissented. Winn made a correct forecast: “If the committee did not act now to assure a reduction in the rates of growth of the aggregates, an excessively restrictive policy would be required later on if the committee’s longer-range objectives were to be achieved” (ibid., 191).
On June 30, the Board voted three to two to increase the discount rate from 7 to 7.25 percent. Miller voted against and, against the advice from other governors, allowed his vote in the minority to be published. That had never happene
d before and it may have heightened concern about his control of policy. Not much happened. Earlier, on May 10, Miller had voted for an increase to 7 percent.
Members continued to make strong statements and take weak actions. In July’s discussion, Governor Partee commented on the continued growth of M 1 in excess of their target. He favored holding M 1 in the 4–6.25 range (FOMC Minutes, July 18, 1978, 26). Mark Willes commented on that: “I don’t see how we are ever going to deal with the inflation problem unless we do something to bring the rate of growth of money down” (ibid., 27). And Paul Volcker added that because of “so much base drift recently,” the FOMC targets were a “farce” (ibid., 28).
Despite these strong statements, action was modest. With reported inflation running about 9 percent annual rate for several months, the FOMC voted seven to three for a funds rate target of 7.75 to 8 percent and an unchanged 4 to 6.5 percent M1 target. Willes complained that the real interest rate was negative and could not be considered restrictive (ibid., 40–41).
The July meeting heard that hourly earnings and producer and consumer prices had increased faster in 1978 than in 1977. Nevertheless, Governors Jackson and Partee dissented from the decision to set annual money growth rates for M1 and M2 at 4 to 6.5 and 6.5 to 9 percent, as at several previous meetings. Jackson preferred a 4 to 7.5 percent band for M1, and Partee wanted the upper limit at 8 percent. The lower limit was below the projected increase in nominal GNP, so it might require slower growth of real GNP.
A History of the Federal Reserve, Volume 2 Page 35