Look at 1960s, not 1970s, to learn how US inflation took hold

McChesney Martin’s mishaps provide warning signals for Jay Powell

Central bankers have been playing down concerns about persistently higher inflation by affirming there is no danger of a return to the wage-price spirals of the 1970s. However, in examining historical parallels with America’s latest 6.2% inflation rate, a 31-year high, analysts may be looking at the wrong period. The 1960s story of the Federal Reserve’s unsuccessful fight against rising prices shows striking similarities to today’s patterns – providing uncomfortable lessons for policy-makers around the world.

In the wake of President Joe Biden’s 22 November decision reappointing Fed Chair Jerome ‘Jay’ Powell, the chronicle of policy errors 60 years ago adds depth to controversies over central banking responses to fast-rising prices. The episodes demonstrate the complex conundrums behind the Fed’s mandate to stabilise prices and control unemployment. In today’s Covid-strained America, as in the rest of the world, where central banks’ multiple goals now have widened to maintaining financial stability, quelling climate change and preventing undue social inequality, these trade-offs can be toxic. All this will be a central focus of Powell’s next four years in office.

William ‘Bill’ McChesney Martin, the steely Fed chair in 1951-70, admitted at the end of his tenure that the acceleration in annual price rises from 1% in 1965 to 6% in 1969-70 partly reflected the US central bank’s own miscalculations. These laid the basis for eventual double-digit inflation that hit America and many other advanced economies after the 1973 oil price rise. This setback was the prelude to years of economic drift that ended only when Paul Volcker as Fed chair in 1979 inaugurated a fierce monetary squeeze to quell what Americans called ‘the great inflation’.

In the 1960s, years of cajoling by Martin’s Fed to persuade President Lyndon Johnson’s administration to restrain the budget deficit failed to pay off. Despite constant soul-searching at Fed meetings on the danger of price rises taking hold in the buoyant American economy, the Fed underestimated the persistence of inflationary pressures.

Fed policy-makers gave higher overall priority to supporting the real economy relative to price stability. And they promoted overheating by overestimating the economy’s productive capacity and underestimating the jobless rate consistent with full employment. As US economic historian Allan Meltzer wrote, ’The use of 4% as the full employment rate [of unemployment] long after that rate rose reflected both error and political pressure.’

The overall political atmosphere made appropriate tightening impossible.

In over 100 Federal Open Market Committee meetings during six years, there was much mention of money, credit and deficit-fuelled overheating. Although unemployment was much discussed, the Fed was not obsessed with this issue (contrary to some accounts of the time). Martin and other prominent Fed officials were hawkishly inclined. Yet the overall political atmosphere – characterised by spending on Johnson’s social programmes and the build-up of the Vietnam war – made appropriate tightening impossible. This state of affairs shows similarities to the pandemic-stretched economy of today.

By 1969, Martin – realising he had made a mistake in easing policies, first in 1967 and again (after a partial reversal) in 1968 – re-applied the anti-inflationary brakes. Shortly before his record-breaking 19-year chairmanship ended in January 1970, he told the other Fed governors he had failed. At his White House farewell party, Martin apologised for his legacy. ‘I wish I could turn the bank over to Arthur Burns [appointed as his successor by Richard Nixon, who took office in January 1969] as I would have liked…. But we are in very deep trouble. We are in the wildest inflation since the Civil War.’

Despite the differences with the Covid world, today’s central bankers face familiar challenges. FOMC meetings in 1965-70 were replete with complaints – echoing current lamentations – about monetary policy taking up an undue share of economic policy burdens. There are strong parallels in the prevalence of supply shortages – material, equipment and labour – amplifying price rises, often regarded in the 1960s (like today) as temporary.

A further similarity stems from the fraught international position. An abrupt increase in US interest rates in 2021-22 could cripple many over-indebted nations. This mirrors tensions six decades ago, in the years leading to Nixon’s 1971 abandoning of the dollar’s gold convertibility and the break-up of the Bretton Woods monetary system. Fed policy-makers feared that undue US tightening could further damage weaker European currencies like sterling or the French franc and even bring down the world’s post-war currency edifice – the eventual result in 1971-73.

Martin kept telling Johnson, ‘We could not have guns and butter.’

In both periods, Fed communications are crucial. Well-publicised tussles with both Johnson and Nixon, where Martin – in public at least – took firm positions, bolstered his reputation as a policy hawk. In 1955 Martin famously likened the Fed to ‘the chaperone who has ordered the punch bowl removed just when the party was really warming up.’ He clashed with Johnson several times over interest rates, when the president accused him of ‘running a rapier’ through him. In reference to spending on the Vietnam war, Martin ‘kept telling [Johnson] we could not have guns and butter. He disagreed. He thought we could have guns and butter.’ In December 1965, the Fed raised the discount rate against Johnson’s wishes – precipitating a celebrated showdown between Johnson and Martin at the president’s Texas ranch.

Martin’s confidence in the self-correcting capabilities of the US system dwindled towards the end of his term – as it became clear that the punchbowl had continued flowing. He told an audience of newspaper editors in 1968: ‘We have an intolerable balance of payments deficit, which goes side by side with an intolerable deficit domestically.’ Unless they were both corrected, the US faced ‘either an uncontrollable recession or an uncontrollable inflation’ – outcomes which came about in the 1970s. Testifying to Congress in 1969, he expressed regrets at the Fed’s decision to ease in 1967 in hopes of getting a tax hike. ‘[A] credibility gap has developed over our capacity and willingness to maintain restraint… We have been unwilling to take any real risks.’

Reviewing the period, economists Athanasios Orphanides and John Williams wrote in 2011, ‘Even when inflation got noticeably higher in the second half of the 1960s, the mistaken belief that the full-employment unemployment rate was very low continued to distort policy decisions, exacerbating inflationary pressures.’

Orphanides, who was a Fed official in the early 2000s and then became governor of the Central Bank of Cyprus, and Williams, who was president of the Fed Reserve Bank of San Francisco Fed and is now president of the New York Fed, wrote, ‘The rise in inflation during 1966 and thereafter vindicated Martin’s position.’  But, they added, this evidence proved insufficient to prevent Fed ‘fine-tuning’ aimed at achieving ‘what was believed to be full employment’.

‘We are in a better place today than the Fed was in 1968. This is despite the spike in inflation.’ 

Orphanides, now a professor at Massachusetts Institute of Technology, says of the present inflation uptick: ‘I hear a lot of misplaced analysis, not fully understanding the errors of 1965-1970. We are in a better place today than the Fed was in, say, 1968. This is despite the spike in inflation.’ In past research, Orphanides spotlighted the Fed’s 1960s miscalculations in measuring inflation and unemployment, leading to mistakes in drawing conclusions from the Phillips curve, which is supposed to compute trade-offs between the two variables. Now, he says, thanks to improved indicators of inflation expectations and better statistical practices, ‘We can track incipient errors sooner.’

Thomas Mayer, founding director of the Flossbach von Storch Research Institute and a former chief economist at Deutsche Bank, who worked at the International Monetary Fund in the 1980s, says growth in money and credit was behind the 1970s malaise. Part of the blame rests with Martin, but his successor Arthur Burns was mainly responsible. ‘A vicious spiral developed: unchecked money growth allowed the price-wage-price spiral to gain momentum.’ Mayer adds: ‘If money growth is the villain – as I believe – we are unlikely to better off now than in the 1970s. Endless quantitative easing has created a formidable monetary overhang, which is just beginning to lift inflation.’

US economics writer Helen Fessenden underlines how Martin ‘as a traditionalist who preferred studying the financial markets rather than formal models… parted company with many of the younger economists joining the Fed, who began assessing a broader range of indicators, including the money supply.’ These refinements, she notes, had not been fully incorporated into the FOMC’s decision-making during the mid-1960s.

Meltzer underlines in his seminal A History of the Federal Reserve that, rather than registering the rapid rise in total reserves (the sum of all bank deposits and cash) and other monetary aggregates in late 1965 and early 1966, Martin focused primarily on the much smaller amount of free reserves and short-term market rates. FOMC documents during the period reveal that the Fed did in fact pay attention to monetary and credit data – including total rather than free reserves – but much less so that would be the case in later years.

‘We have been seeking faster growth and lower unemployment than are consistent with price stability.’

Alfred Hayes, president of the New York Fed (like Martin, for 19 years) and FOMC vice-chairman, known to be a lightning-fast mathematician, was a notable Martin ally. He deployed more technical language than the chairman – which may have weakened the cohesion of their alliance. Hayes habitually spoke during FOMC meetings for much longer than Martin. He warned near-continuously of destabilising monetary data, the need to protect America’s depleting gold stock and for tax increases to rein budget deficit, and the inconsistency of employment goals with price stability.

Hayes cautioned in January 1968, ‘As a nation we have been seeking a somewhat faster rate of growth and a lower rate of unemployment than are consistent with cost price stability.’ In December 1969, the penultimate FOMC meeting of the Martin era, Hayes warned of ‘the possibility of wage and price controls as the only answer’. This presaged Nixon’s wage controls in August 1971 accompanying the suspension of dollar-gold convertibility.

When Nixon won the November 1968 election, he immediately tried to replace Martin with Burns, former chairman of the council of economic advisors in 1953-56 under President Dwight Eisenhower. Nixon distrusted Martin, blaming Fed policies for his earlier defeat in the 1960 election. The president-elect offered Martin the post of Treasury secretary, but Martin said he intended to serve out the balance of his Fed board membership. Burns took a new ‘waiting room’ position as Nixon’s White House ‘counsellor’ and was duly nominated as Martin’s replacement in October 1969.

At Burns’ White House swearing-in ceremony on 31 January 1970, Nixon pointed the way ahead. ‘I have some very strong views on some of these economic matters and I can assure you that I will convey them privately and strongly to Burns,’ he said. ‘I respect his independence. However, I hope that independently he will conclude that my views are the ones that should be followed.’ Burns obliged, cutting discount rate five times in his first two years of office – encapsulating the new Fed chair’s subservience to Nixon’s political will, accompanied by significant increases in the money supply.

Stepping hard on the brakes ‘would be frustrating the will of the Congress.’

In September 1979, 18 months after the end of his eight years as Fed chief, a period of worldwide monetary upheavals and double-digit inflation, Burns delivered a fatalistic view of his troubled chairmanship. He made clear that the Fed’s main priority had been preventing job losses.

In a lecture at the annual IMF meeting in Belgrade, Burns reflected that Fed credit tightening to counter ‘upwards pressure on prices released or reinforced by governmental action’ tended to cause ‘severe difficulties’ for the economy. Stepping hard on the brakes, he philosophised, meant that the Fed ‘would be frustrating the will of the Congress, to which it was responsible [for] assuring that jobs and incomes were maintained, particularly in the short run’. This was the root cause, he claimed, of central bankers’ ‘anguish’:  despite their continually reinforced ‘abhorrence’ of inflation and the ‘powerful weapons they could wield against it’, central bankers had ‘failed so utterly’ in their mission to bring it under control’.

Burns’ remarks, a curtain-raiser for the era of Paul Volcker, summed up the fraught state of 1970s central banking. Yet the trail to the malaise was laid already in the previous decade. For Powell and his fellow Fed policy-makers, McChesney Martin’s mishaps provide warning signals for what may be a bumpy ride ahead.

David Marsh is Chairman of OMFIF.

Join Today

Connect with our membership team

Scroll to Top