THE BULLETIN, March 2022
Inflation: supply or demand led?

Return of guns and butter: war, inflation and central banks

Lessons of the 1960s – how William McChesney Martin’s errors could haunt Powell, Lagarde and Bailey

Russia’s invasion of Ukraine is coinciding with persistent inflation, fuelled by surging energy prices, just as during the height of the cold war, writes David Marsh.

THE world’s three most widely followed central banks – the Federal Reserve, European Central Bank and Bank of England – have all got their inflation forecasts spectacularly wrong over the past 12 months. Jerome ‘Jay’ Powell, Christine Lagarde and Andrew Bailey all admit this. They lay the blame on faulty diagnosis of economic dynamics at the end of the Covid-19 crisis as well as on collective complacency about what was seen as a ‘temporary’ spike in energy prices last year. A statement in July 1969 by William ‘Bill’ McChesney Martin – Fed chair in 1951-70, much vaunted as an inflation-fighter, but a man who ultimately failed in his mission – could turn out to haunt present-day central bankers. ‘The System was overly hasty in moving toward ease in the summer of 1968, in part because of faulty judgments but also because of faulty projections.’

With the mood darkening after the start of the Russian invasion of Ukraine on 24 February, parallels with the 1960s and 1970s are growing ever more striking. As during the peak of the cold war and the Vietnam war, armed conflict is coinciding with the social and economic pressures of persistent inflation fuelled by soaring energy prices. Central banks and governments – just as they did 50 years ago – will be attempting the difficult trade-off of countering inflationary spikes and maintaining economic growth. The strong probability is that they will end up achieving neither aim. Jacques de Larosière, a doyen of the international central banking community, a former governor of the Banque de France and managing director of the International Monetary Fund, sums up the gloomy position: ‘I very much agree on the danger of the stagflation that we are facing. Study of the 1960s will be helpful: most of these central bankers don’t know how inflation operates.’

Another difficult balancing act will be the task of reconciling politicians’ desire for ‘guns and butter’. Even though financial markets provide governments far more leeway for borrowing than 50 years ago, combining the necessity of higher military spending with commitments on social and ‘green transition’ programmes will be an immense challenge.

For today’s central bankers forced into multiple damaging policy and forecasting U-turns (see ‘Reality hits home – central banks adjusting to higher inflation’), Martin’s legacy represents a cautionary tale. Martin is the author of one of the most celebrated phrases in central banking folklore. In 1955 he likened the Fed to ‘the chaperone who has ordered the punch bowl removed just when the party was really warming up.’

Acquiescing in easy money policies

After numerous clashes with Presidents Lyndon Johnson and Richard Nixon, he acquiesced to what he later admitted were over-easy money policies, preparing the way for eventual double-digit inflation that hit America and many other advanced economies after the 1973 oil price rise. The reality of the latter Martin years is that the punchbowl kept on flowing – leading to an inflationary surge curbed only with the drastic tightening inaugurated by Paul Volcker when he took over as Fed chairman in 1979.

Today’s central bankers are reacting to the pressures in different ways. In the US, where the inflation rate for February reached 7.9%, the highest since 1982, Powell has made clear that the Fed will stick to its path of raising interest rates at the next Federal Open Market Committee meeting on 15-16 March. In the euro area, where the 5.8% February inflation rate was the highest since the birth of the single currency, the mood is much more circumspect. Signals of future tightening at the European Central Bank’s 10 March governing council meeting were relatively muted on account of worries about European growth and plunging stock markets. The ECB says it is ready to cut back asset purchases faster than earlier indicated. But further-reaching plans laid above all by Germany’s Bundesbank for a much-delayed return to monetary ‘normalisation’ have been toned down. In the UK, where the January inflation rate was 5.5%, the highest since 1992, the Bank of England is likely to continue modest tightening amid expectations that the rate will peak around 7.25% next month.

Back in the 1960s, the growing inflation problem was a perennial headache for the FOMC, meeting every three weeks and linking the Fed’s board of governors and staff economists with the regional Fed presidents. In the final six years of Martin’s 19-year chairmanship, the Fed’s transcripts reveal that the central bank repeatedly discussed rapid growth of money and credit – contrary to widespread supposition that the Fed ignored these parameters.

The Fed’s records feature agonisingly complex discussions about the compromises and trade-offs involved in steering appropriate policy. There were six distinct phases of reaction (see ‘McChesney Martin’s mishaps – the six phases of inflation malaise’)  to the swirling domestic and international policy environment , from  ‘Equanimity’ in 1964 through  ‘Forbearance’ in 1966  to ‘Acquiescence’ in 1969. The dilemma was summed up in March 1965 by Guy Noyes, one of the vocal band of staff economists at the heart of Fed policy-making: ‘There is growing concern that our economy may be developing a classic form of instability… The fact that some observers are inclined to focus their attention on the boom side of this cycle and its inflationary potential, while others are preoccupied with the subsequent bust and its impact on our employment and growth objectives, should not trap us into the comforting but erroneous conclusion that these concerns can be offset against one another.’

‘Price and wage effects of an effort to produce both guns and butter’

Significantly, the most voluble protagonists in the debates about rapid increases in money supply and bank reserves were outside the board of governors – FOMC members and alternates from the regional Federal Reserve banks. In September 1967, for example, George Ellis, president, Federal Reserve Bank of Boston, told the FOMC: ‘With an economy showing the price and wage effects of an effort to produce both guns and butter, and with the administration pleading with Congress to recognise the need to reduce private spending by taxation, it seems incredible that monetary policy should hold at the same throttle positions of net free reserves, rate of reserve creation, rate of bank credit creation and rate of money creation seen in the first quarter of this year.’

Board staff economists’ analysis of money and credit developments appears to have been relatively scarce.

Reality hits home  – central banks adjusting to higher inflation

US Federal Reserve

‘I’m inclined to propose and support a 25 basis points rate hike [on 15-16 March]. The bottom line is that we will proceed, but we will proceed carefully as we learn more about the implications of the Ukraine war for the economy… To the extent inflation comes in higher or is more persistent… then we would be prepared to move more aggressively by raising the federal funds rate by more than 25 basis points [at one or more meetings].’

Jerome Powell, 2 March 2022


‘[Since the last meeting in December] expectations for inflation have become just a bit worse. [There is] quite a lot of room to raise interest rates without threatening the labour market.’

Jerome Powell, 26 January 2022


‘If we see inflation persisting at high levels longer than expected, then if we have to raise interest more over time, we will. We will use our tools to get inflation back.’

Jerome Powell, 11 January 2022


‘Generally, the higher prices… are related to the supply and demand imbalances that can be traced directly back to the pandemic and the reopening of the economy. But… price increases have spread much more broadly across the economy. I think the risk of higher inflation has increased.’

Jerome Powell, 30 November 2021


‘[High inflation is] likely to last well into next year; the same is true for pressures on wages.’

Jerome Powell, 22 October 2021


‘The combination of strong demand for goods and the bottlenecks has meant that inflation is running well above target. We expect that it will continue to do so in the coming months before moderating as bottlenecks ease.’

Jerome Powell, 29 September 2021


Jerome Powell, 14 July 2021


‘I’m much more worried about falling short of a complete recovery… I’m much more concerned about that than the possibility… of higher inflation… Frankly, we’d welcome higher inflation.’

Jerome Powell, 27 January 2021

Bank of England

‘There is a risk there will be higher inflation for longer… It’s not just wage setting, it’s also price setting. There is very clearly an upside risk there. The upside risk comes from the second-round effects.’

Andrew Bailey, 23 February 2022


‘If you think about the relationship between transitory and these second-round effects that can make it much longer, that again is a source of pressure in this story, which is a concern.’

Andrew Bailey, 19 January 2022


‘I’m very uneasy about the inflation situation. It is not, of course, where we wanted to be, to have inflation above target. I tend to play down the comparison with the 1970s. The inflation story in the 1970s was much worse and persistent throughout the decade.’

Andrew Bailey, 15 November 2021


‘We are in a very fragile period, because we’ve got inflation going well above target. The warning signs are there, the bells are ringing, so we have to watch this carefully.’

Andrew Bailey, 4 November 2021


‘We expect inflation to rise to around 5% in the spring next year. We expect these high rates of inflation to be temporary.’

Monetary policy report, 4 November 2021


‘Energy prices mean inflation will last longer and it will get into the annual numbers for longer as a consequence. That raises for central banks the fear and concern of embedded expectations.’

Andrew Bailey 17 October


‘We expect this rise in inflation to be a temporary feature. The reasons are well-founded; it is not a vain hope or a matter of whistling in the wind. It is important not to over-react to temporarily strong growth and inflation, to ensure that the recovery is not undermined by a premature tightening.’

Andrew Bailey, 1 July 2021

European Central Bank

‘If forecasts indicate that the inflation target will be reached within the projection horizon, waiting for realised inflation to converge to the target before tightening might be excessively costly… If the forecasts indicate that inflation will fall below the target level over the projection horizon… premature monetary tightening runs the risk of an economic slowdown… Assessing these different types of policy errors is especially difficult [with] high uncertainty.’

Philip Lane, 2 March 2022


‘Today, inflation is not only higher than expected, but price pressures are also visibly broadening. Measures of underlying inflation are following an unprecedented upward trend. Current measured inflation would be even higher if the costs of owner-occupied housing were included.’

Isabel Schnabel, 24 February 2022


‘Demand conditions in the euro area do not show the same signs of overheating that can be observed in other major economies. This increases the likelihood that the current price pressures will subside before becoming entrenched.’

Christine Lagarde, 7 February 2022


‘Price rises have become more widespread, with the prices of a large number of goods and services having increased markedly. The role of temporary pandemic factors means that the persistence of these increases remains uncertain. Market-based indicators suggest a moderation in energy price dynamics in the course of 2022.’

Christine Lagarde, 3 February 2022


‘A rising carbon price, higher tax rates across a range of fossil fuels and relatively inelastic energy demand may lead to continuous upward pressure on consumer prices in the transition period.’

Isabel Schnabel, 8 January 2022


‘Inflation will fall less than we all had all envisaged a year ago, but it will fall.’

Christine Lagarde, 20 January 2022


‘Under the present circumstances, it is very unlikely that we will raise interest rates in the year 2022. But we have to be very attentive to what data tells us.’

Christine Lagarde, 17 December 2021


‘I see an inflation profile that looks like a hump… and a hump eventually declines… 55%-60% of inflation is from energy prices… By the end of 2022 it will have declined significantly.’

Christine Lagarde, 3 December 2021


‘Most forecasts assume inflation will fall below 2%. If we thought inflation would permanently settle above 2%, we would definitely react. However, at the moment, we see no indications of this.’

Isabel Schnabel 29 November 2021


‘We still see inflation moderating in the next year, but it will take longer to decline than originally expected.’

Christine Lagarde, 15 November 2021

William McChesney Martin

‘I wish I could turn the bank over to Arthur Burns as I would have liked… But we are in very deep trouble. We are in the wildest inflation since the civil war.’

William McChesney Martin, January 1970


‘The Committee’s policy in the first half of 1969 was less restrictive than intended. It was only recently that the desired degree of restraint had been achieved and it would be a mistake to back off now.’

William McChesney Martin, October 1969


‘I am deeply concerned about the outlook for the surtax extension bill; there is a real possibility that it will not be enacted. The Committee should call for holding as closely as feasible to the present degree of pressure. It would be a mistake to take any action that might reinforce inflationary expectations. The System was overly hasty in moving toward ease in the summer of 1968, in part because of faulty judgments but also because of faulty projections.’

William McChesney Martin, July 1969


‘The primary problem is inflationary psychology. There are many signs indicating that inflation was becoming a way of life in the nation today. Policy-makers have to come to grips with the problem.’

William McChesney Martin, April 1969


‘To Mr Nixon I expressed the view that inflation was the primary economic problem now facing the nation… The System continues to face the problem of dealing with the heritage of errors from past economic policies.’

William McChesney Martin, January 1969


‘Members of the Committee, including myself, and the staff, have underestimated the strength of the economy. While there are some signs of a slowing, this is much less than expected. But policy should not be firmed now. It would be asking too much of monetary policy to expect it to deal with the inflationary psychology resulting from the cumulated heritage of past failures of public policy.’

William McChesney Martin, November 1968


‘It is the unanimous view of the members today that greater monetary restraint is desirable. However, there are problems of timing. … I want to increase restraint gradually and unaggressively. ’

William McChesney Martin, March 1968


‘Inflationary pressures once again have got ahead of stabilisation policy. Inflation is no longer prospective; it is a present reality.’

William McChesney Martin, October 1967


‘This is a time of intellectual bafflement and confusion such as has seldom been witnessed in the country’s history. People are divided on many issues, and it is not surprising that views on appropriate monetary policy differ.’

William McChesney Martin, September 1967


‘Even though the inflationary updrift in costs and prices has not completely subsided, a lessening of aggregate demand pressures has become increasingly evident…. The President’s request for a tax increase is a prudent proposal, and it has my full support.’

William McChesney Martin, January 1967


‘The System will now be operating in an entirely new environment–-one that had not been contemplated a year ago–of full employment generally and over-full employment of skilled workers.’

William McChesney Martin, January 1966


‘The time is coming when the System has to move one way or the other. It will not be possible simply to stay put.’

William McChesney Martin, November 1965


‘There are many signs of inflation and of inflationary psychology. … The Committee has a tendency to wait until all the evidence is in before making a policy change. The difficulty is that when all the evidence is in it is likely to be too late… I have talked with the chairman of the council of economic advisers, with Treasury officials, and with the President. They all had expressed the view that it would be unwise to change monetary policy now.’

William McChesney Martin, October 1965


‘There are still inflationary pressures in the economy. The volume of credit, however measured, is dangerously high … this will be revealed by coming developments.’

William McChesney Martin, March 1965

Note: Jerome Powell is chair, Federal Reserve Board. Christine Lagarde is president, European Central Bank. Philip Lane and Isabel Schnabel are ECB board members. Andrew Bailey is governor, Bank of England. William McChesney Martin was Fed chair, 1951-70.

As Martin acknowledged towards the end of his tenure, the Fed repeatedly over-estimated the Johnson administration’s ability to enact tax increases to counter the budget deficit fuelled by social programmes and the Vietnam war. And the central bank’s easing moves in 1967 and 1968, enacted partly to balance planned government budgetary cuts, turned out to be miscalculations.

The Fed mistakenly believed a jobless rate above the 4% estimated to represent full employment would put a brake on cost pressures. In fact – in a parallel to the US position in 2021-22 – the American economy was already running at full employment – the relevant level was later calculated to be appreciably higher than 4%. FOMC members frequently complained that the Fed was being cast into the political ‘hot seat’ by taking an unfairly large share of the burden in the fight against rising prices. Martin’s repeated lament was that the Fed could not undo the ‘cumulated heritage’ of past failures of public policy.

Martin had served with distinction alongside four presidents: Truman, Eisenhower, Kennedy and Johnson, but was unsettled politically after Nixon as president-elect tried to dislodge him in December 1968. Afterwards, Martin could do little to hold back the inflationary tide. When Arthur Burns, groomed by Nixon as a compliant successor, took over in February 1970, the tide – swollen by world currency upheavals and the1973 rise in oil prices – became unstoppable.

Stepping on the brakes ‘would be frustrating the will of 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 International Monetary Fund 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 a decade earlier – a lesson that today’s central bankers would do well to heed.

McChesney Martin’s mishaps – the six phases of inflation build-up

Phase 1 – 1964
Equanimity: Calm waters

‘I do not regard the outlook as inflationary’

January 1964

‘There is no need at present for a change in policy. There is no domestic boom. Price changes are mixed, despite an underlying inflationary potential. Bank credit expansion, though large since mid-year, has moderated.’ – Braddock Hickman, President, Federal Reserve Bank of Cleveland

‘Wage rates increased 3% last year, but wage costs were kept down and this was reflected in prices. The US had benefited so far by not inflating so fast as had France, Italy, and some other countries. If the struggle to keep wage costs down were lost this year because of high profits, the US would join in the inflationary race.’ – Canby Balderston, Vice-Chair, Board of Governors

June 1964

‘I do not assess the outlook as inflationary, in the sense that term describes the mid-1950s. There do not appear to be either the general economic preconditions or the pervasive psychology to support a repeat performance.’ – Daniel Brill, Board Economist

‘Government policies make inflation ultimately inevitable. So-called “selective” price increases are exactly the kind of increases that consumers are not able to resist.’ – Malcolm Bryan, President, Federal Reserve Bank of Atlanta

September 1964

‘What about the ability of the economy to support further sizeable expansion without speculative excesses or inflation? The situation continues to look reasonably favourable. The unemployment rate has drifted down irregularly a half point since the beginning of the year, but at 5.1% in August it is still uncomfortably high, particularly since the total conceals the much higher rates among teenagers, non-whites and those unemployed for long periods. Of course, the more the unemployment problem becomes a structural one, the greater become the chances for inflationary wage bidding for skilled workers.’ – Albert Koch, Board Economist

‘Domestically, the recent behaviour of commodity prices might suggest increased inflationary pressures, but to a large extent recent price rises had been confined to limited segments of the economy and appeared to be related to factors other than basic money and credit conditions.’ – Edward Wayne, President, Federal Reserve Bank of Richmond

‘None of the broader measures of significance for policy have moved in a direction that would call for further monetary tightening. The unemployment uptick in August confirms that improvement in this vital area is still painfully slow. Prices are still bubbling in the non-ferrous metals area. This kind of price action, however, is not unusual in an expansion, and the sectors of the economy directly involved are small… We are still in the midst of a non-inflationary business expansion.’ – James Robertson, Vice-Chair, Board of Governors

‘Employment, prices, and anticipations continue to reflect moderation. Business is good enough to support a near-record level of employment but not good enough to reduce unemployment to an acceptable level. Business is good enough to send corporate profits to record levels and production closer to the preferred rate of capacity but not sufficiently heated to push wage rates and unit costs into a spiral of price inflation.’ – Karl Bopp, President, Federal Reserve Bank of Philadelphia

December 1964

‘The industrial wholesale price index appears to be under somewhat more upward pressure. However, it is too early to say whether a pervasive spread of upward price pressures is in the making; and it is somewhat reassuring that business pricing expectations for 1965 seem to give little indication of any developing inflationary psychology.’ – Alfred Hayes, President, Federal Reserve Bank of New York

Phase 2 – 1965
Apprehension: Gathering clouds

Discount rate raised from 4% to 4.5%, 6 Dec 1965

‘The vaunted price stability showing signs of terminating’

January 1965

‘Businessmen do not give the impression that they are thinking about potential inflation in the usual terms, such as rising wage costs. Their primary concern is with the position of the dollar… and the possibility of a rather substantial increase in federal spending in the second half of 1965 after the passage of legislation implementing the “great society”.’ – Watrous Irons, President, Federal Reserve Bank of Dallas

‘The vaunted price stability is showing signs of terminating; in the fourth quarter wholesale prices excluding farm and food products rose 0.6%. I do not want to say that the economy is faced with price inflation but… there should be progress in reducing the prices of exportable goods.’ – Canby Balderston, Vice-Chair, Board of Governors

‘Barring a steel strike and taking into account the stimulus that the federal budget may exert in the second half of the year, sustained expansion through 1965 seems likely. There is a risk, still latent, that inflationary pressures may develop.’ – Alfred Hayes, President, Federal Reserve Bank of New York

‘I have reluctantly concluded that the Committee should move at least slightly in the direction of less ease. I favour moving toward a lesser availability of reserves.’ – Malcolm Bryan, President, Federal Reserve Bank of Atlanta

March 1965

‘After four years of almost incredibly stable expansion, there is growing concern that our economy may be developing a classic form of instability – the boom-bust inventory whipsaw that so often frustrated our efforts to maintain stable growth.’ – Guy Noyes, Board Economist

‘The recent 20% growth rate in time and savings deposits and the concurrent rapid increase in total assets held by banks are an inflationary development.’ – Braddock Hickman, President, Federal Reserve Bank of Cleveland

‘The accelerated rise in time and savings deposits… at some point this could have inflationary consequences; it apparently had not thus far, but one could not be sure how long this situation would continue.’ – Alfred Hayes, President, Federal Reserve Bank of New York

‘There are still inflationary pressures in the economy. The volume of credit, however measured, is dangerously high at present and this will be revealed by coming developments.’ – William McChesney Martin, Chair, Board of Governors

April 1965

‘The likelihood of the economy overheating in the near term future can be discounted a bit more now that we have got through several months of unsustainably rapid rate of economic expansion with few additional outward signs of inflation.’ – Albert Koch, Board Economist

‘There does not seem much evidence that rising labour costs are forcing upward price adjustments. However, the strength of demand is keeping producers looking to see if they could make price increases stick were they to announce them.’ – George Ellis, President, Federal Reserve Bank of Boston

‘Escalation of the conflict in Vietnam could change the situation’

Vietnam war. Picture©Pixabay

September 1965

‘We have a good chance of steering the middle course of maintaining our current rate of expansion without veering off into the ditches of either inflation or recession.’ – Albert Koch, Board Economist

‘Announcements of individual price increases seem to be becoming more frequent. The threat of inflationary tendencies remains quite serious. The exuberant stock market is one more manifestation of incipient inflationary psychology.’ – Alfred Hayes, President, Federal Reserve Bank of New York

‘Although escalation of the conflict in Vietnam could change the situation, the prospects are for a continued absence of overall inflationary pressure.’ – Karl Bopp, President, Federal Reserve Bank of Philadelphia

‘Expansionary forces definitely are at work. I am not ready to accept the statement that the steel settlement was non-inflationary… Upward pressures on prices will be manifest… It is important to try to forestall any outbreak.’ – Charles Shepardson, Board of Governors

October 1965

‘The performance of the economy is strong… Both an inflationary surge and an adjustment that would stall our forward momentum remain possibilities for the future, but it is very hard to show that either of these unpleasant prospects is imminent.’ – Guy Noyes, Board Economist

‘The odds favour some tranquillity: We’ve got through a period of extraordinary demands with nothing worse than a price creep. Short of introduction of a major military spending programme, it’s hard to see anything on the horizon that would significantly accelerate this price creep.’ – Daniel Brill, Board Economist

‘We have a real basis for concern about potential inflationary pressures, against a background of cumulative large increases in bank credit and a serious international payments problem… Another reason for prompt action is to dispel the unfortunate but widespread notion that the System has lost control of monetary policy.’ – Alfred Hayes, President, Federal Reserve Bank of New York

‘We need to be very careful not to base our decisions on the judgments that inflationary conditions are bound to develop, just because they have in past expansions.’ – James Robertson, Vice-Chair, Board of Governors

‘Satisfactory as the System’s monetary policy has been between the years 1961 and 1964, it is appropriate to ask if the System should not now take steps to prevent steady business expansion from being undermined by interest rate distortions and by inflationary pressures.’ – Canby Balderston, Vice-Chair, Board of Governors

‘I am concerned about creeping inflation. There are many signs of inflation and of inflationary psychology… [Committee] policy changes have tended to be too late rather than too early. The Committee has a tendency to “wait until all the evidence was in” before making a policy change. The difficulty is that when all the evidence is in it is likely to be too late. That might be the situation the Committee faces now. Nevertheless, the Committee should not make a policy change today. Last week I gave the President [Johnson] a paper expressing his personal views… I have talked with the chairman of the council of economic advisers, with Treasury officials, and with the President. They all expressed the view that it would be unwise to change monetary policy now.’ – William McChesney Martin, Chair, Board of Governors

November 1965

‘Cost-price stability is always one of our major objectives. In the present international setting this objective becomes doubly important. The economy looks strong enough to absorb a tightening of monetary policy without adverse effects. Such a policy change may be required in the near future to help prevent an inflationary outburst.’ – Alfred Hayes, President, Federal Reserve Bank of New York

‘There is no concrete evidence of general inflation, although actual transaction prices might be increasing more than the official indexes. Prices, along with business inventories, are areas where the Committee knew too little.’ – Braddock Hickman, President, Federal Reserve Bank of Cleveland

‘The time is coming when the System has to move one way or the other. It would not be possible simply to stay put. The Treasury’s financial problem, which is the major problem ahead, will either be solved by a pause in business activity and a decline in the demand for business loans or by an aggressively easier policy by the Federal Reserve.’ – William McChesney Martin, Chair, Board of Governors

‘The time for decision has arrived.’

November 1965

‘Appropriate policy decisions are especially difficult. It might not take much of a move toward ease or restraint of either monetary or fiscal policy to tip the scale toward inflation on the one hand or recession on the other.’ – Albert Koch, Board Economist

‘We are probably very close to the point where continued sustainable domestic expansion depends on greater effort to keep inflationary pressures under control. It seems no more than prudent to try once again to slow the recent excessive rate of bank credit expansion. A discount rate increase would permit greater reliance on market forces on interest rates in channelling the flow of funds.’ – Alfred Hayes, President, Federal Reserve Bank of New York

‘It is difficult to feel secure when the money supply is expanding at 7.6% (on a three-month average) while GNP is expanding 4.7% in real terms.’ – George Ellis, President, Federal Reserve Bank of Boston

‘We should go no further in tightening monetary policy at this juncture. On the price front, the gradual up-creep in the general industrial commodity index has slowed down.’ – James Robertson, Vice-Chair, Board of Governors

‘The chance of serious price inflation in commodities is greater than at any time in the past four years. But it could not be known that this would happen.’ – Braddock Hickman, President, Federal Reserve Bank of Cleveland

‘The time for decision has arrived. It is not possible to run away continually from making a decision… Talk about market expectations could work both ways. In the market the expectations are just as much that the President would not allow any interest rate changes as to the contrary. That creates a very real problem.’ – William McChesney Martin, Chair, Board of Governors

‘All indicators show sufficient strength in the economy to withstand some restraint. The Committee has been putting off such action until everyone could point to clear evidence. It is time to let up on the gas pedal and put on the brakes.’ – Charles Shepardson, Board of Governors

December 1965

‘The general reaction of the securities markets to the change in the discount rate was one of relief that the air had been cleared by a decisive move.’ – Alan Holmes, Manager, Federal Reserve System Open Market Account, Federal Reserve Bank of New York

‘New data show a continuing build-up of inflationary pressures, higher consumer and wholesale prices, increasing labour shortages, higher wage rates and hourly earnings, faster growth in personal income, accelerated capital spending, sharp increases in new and unfilled orders for durable goods, and a considerable increase in the deficit in the cash budget.’ – Edward Wayne, President, Federal Reserve Bank of Richmond

Phase 3 – 1966
Forbearance: Pressures mount

No change in discount rate

‘With inflation a real and present danger, a coordinated government programme is needed to preserve the integrity of the dollar.’

January 1966

‘Developments in the recent past and future prospects suggest a rate of economic expansion that could be creating problems of a destabilising nature – first inflation and subsequently readjustment.’ – Albert Koch, Board Economist

‘In the current economic climate of an unexpectedly favourable profit experience and strong consumer demand, businessmen and market participants tend to become exuberant. Add to this the near-certainty of a substantial Treasury deficit, and you have a situation in which inflationary expectations are almost bound to win the upper hand.’ – Alfred Hayes, President, Federal Reserve Bank of New York

‘Employment is up significantly further, and the long-hoped-for breakthrough to an unemployment rate below 4% is finally said to be just around the corner… Accordingly, I am prepared to have monetary policy make a substantial and positive contribution to damping such inflationary pressures.’ – James Robertson, Vice-Chair, Board of Governors

‘The danger of incipient inflation is clear, and the Committee’s main task is to keep monetary policy sufficiently flexible to do what it can to contain inflationary pressures.’ – Dewey Daane, Board of Governors

‘The System will now be operating in an entirely new environment – one that had not been contemplated a year ago – of full employment generally and over-full employment of skilled workers. I would favour a little inflation if I thought it would benefit the unemployables, but I do not think it would; rather, it would do them harm.’ – William McChesney Martin, Chair, Board of Governors

‘The business situation and outlook remain very strong, with the Vietnam build-up a major contributing factor. The most disturbing feature of the economy at present is the growing evidence of inflationary pressures.’ – Alfred Hayes, President, Federal Reserve Bank of New York

May 1966

‘The need for restraint is clear. With many key interest rates higher than at any time in the post-war years, the risks of forcing monetary policy to carry the burden alone are not inconsiderable… I have been very much disappointed to observe the great reluctance of the administration to embrace widespread proposals for a tax increase.’ – Alfred Hayes, President, Federal Reserve Bank of New York

‘The Committee could hardly conclude that it had done much toward combating inflation during the past five months. When members looked at total reserves or non-borrowed reserves… they must be appalled. In the five months since December, the Committee has poured more reserves into the banking system than in the entire previous year, larger than in any full year since 1951.’ – Sherman Maisel, Board of Governors

‘Additional fiscal restraint would be highly desirable. The Federal Reserve should continue to apply pressure on the commercial banking system and the financial markets.’ – George Clay, President, Federal Reserve Bank of Kansas City

‘If we are seeing the beginning of a domestic price-wage spiral, we may be risking a 10-year setback.’

June 1966

‘If we are now seeing the beginning of a domestic price-wage spiral that could gather momentum right into the next recession, as happened in the late 1950s, and if some other leading countries are about to be successful in slowing down their inflations, also as in the late 1950s, then we may be risking a 10-year setback.’ – John Reynolds, Board Economist

‘More fiscal restraint would lessen the need to place too great an anti-inflationary burden on monetary policy and would reduce the inevitable pressure on interest rates.’ – William Treiber, First Vice-President, Federal Reserve Bank of New York

July 1966

‘The need for a continued general policy of restraint seems clear in view of the still excessive rate of credit growth, the continuing inflationary danger, and the parlous state of our balance of payments.’ – Alfred Hayes, President, Federal Reserve Bank of New York

‘Price developments continued to be disquieting… The country could easily drift into cost-push inflation.’ – Braddock Hickman, President, Federal Reserve Bank of Cleveland

‘The System has again been put squarely on the political hot seat.’

September 1966

‘President [Johnson’s] announcement of a new anti-inflationary programme came at a time when the market rally was running out of steam… Most market participants felt that the programme was not forceful enough… although many also felt that the System had again been put squarely on the political hot seat.’ – Alan Holmes, Manager, Federal Reserve System Open Market Account, Federal Reserve Bank of New York Holmes

‘Business developments indicate that the economy is still growing at a rapid rate and is likely to continue to grow at a rate generating inflationary pressures well into 1967.’ – Alfred Hayes, President, Federal Reserve Bank of New York

‘The economy remains tilted toward inflation as it expanded rapidly, with continuing pressures on available resources.’ – George Ellis, President, Federal Reserve Bank of Boston

‘Labour markets continue to be extremely tight and inflationary pressures remain dominant. Shortages of labour, skilled and unskilled, continue in virtually all District centres.’ – Charles Scanlon, President, Federal Reserve Bank of Chicago

‘Wage-cost inflation has been built into the economy, due almost entirely to the failure of the administration to take appropriate fiscal action earlier this year. Monetary policy alone has done about all that it could to restrain the economy. A further tightening could aggravate imbalances.’ – Braddock Hickman, President, Federal Reserve Bank of Cleveland

Phase 4 – 1967
Pacification: Pause in expansion

Discount rate cut from 4.5% to 4%, 7 April 1967, raised to 4.5% 20 November

‘It has become possible to relieve the tautness of domestic money market conditions… The President’s request for a tax increase is a prudent proposal.’

January 1967

‘We have done best on the employment goal. Indeed, there have been many shortages of skilled labour, and even of unskilled labour. Monetary policy has been left with too much of the burden of fighting inflation.’ – William Treiber, First Vice-President, Federal Reserve Bank of New York

‘Widespread signs of moderation in economic advance are hopefully the signs of adjustment toward a non-inflationary rate of economic growth and not the signs of emerging recession.’– Edward Wayne, President, Federal Reserve Bank of Richmond

‘Even though the inflationary updrift in costs and prices has not completely subsided, a lessening of aggregate demand pressures has become increasingly evident… the President’s request for a tax increase is a prudent proposal, and it has my full support.’ – William McChesney Martin, Chair, Board of Governors

May 1967

‘We have been enjoying some welcome relief on the price front; substantial recent declines in agricultural and sensitive industrial materials prices, and a levelling off in industrial product prices, have pushed average wholesale prices down and moderated the rise in the consumer price index.’ – John Charles Partee, Board Economist

‘Despite the improved economic outlook, it would seem premature now to enhance or justify market fears of a return to restraint.’ – Daniel Brill, Board Economist

‘Continuing the recent rapid monetary expansion might add to inflation that had not yet been brought fully under control. Yet contracting the monetary aggregates might foster recession.’ – Darryl Francis, President, Federal Reserve Bank of St. Louis

July 1967

‘As for monetary policy, it seems to me that no change in policy is the wise choice for the immediate future despite the strong underlying case for some firming of policy in the light of inflationary risks, the balance of payments situation, and the need to moderate the growth of bank credit and deposits.’ – Alfred Hayes, President, Federal Reserve Bank of New York

‘This is a time of intellectual bafflement and confusion as seldom witnessed in the country’s history.’

September 1967

‘Even if one grants that a vigorous economic expansion is still uncertain, I can be quite concerned by the threat of serious further wage and price inflation. This is a major threat, but the period of most rapid overall price escalation may be over.’ – Daniel Brill, Board Economist

‘With our international position remaining very unsatisfactory, and with bank credit tending to grow too rapidly, the desirability of some modest move toward less monetary ease seems clearly indicated.’ – Alfred Hayes, President, Federal Reserve Bank of New York

’I favour a modest move in the direction of restraint. I continue to be concerned about the recent high rates of increase in reserves, bank credit and the money supply, in view of the prospects for rapid economic growth and existing inflationary pressures.’ – Eliot Swan, President Federal Reserve Bank of San Francisco

‘With an economy showing the price and wage effects of an effort to produce both guns and butter, and with the administration pleading with Congress to recognise the need to reduce private spending by taxation, it seems incredible that monetary policy should hold at the same throttle.’ – George Ellis, President, Federal Reserve Bank of Boston

‘I would not assert that monetary policy was not too easy, but it would be foolish for the Committee, after having maintained its policy to this point, to launch a probing operation… This is a time of intellectual bafflement and confusion such as has seldom been witnessed in the country’s history. People are divided on many issues, and it is not surprising that views on appropriate monetary policy differ.’ – William McChesney Martin, Chair, Board of Governors

October 1967

‘The assumed fiscal restraint, coming perhaps six months later than it should, cannot be expected to produce miracles over the next six months. It should, however, contribute promptly to dampening the psychology of inflation.’ – Daniel Brill, Board Economist

‘Inflationary pressures once again have got ahead of stabilisation policy. Inflation is no longer prospective; it is a present reality.’ – William McChesney Martin, Chair, Board of Governors

Phase 5 – 1968
Defiance: Inflation rebounds

Discount rate raised from 4.5% to 5%, 22 March 1968; raised to 5.5%, 19 April; cut to 5.25%, 30 August; raised to 5.5%, 18 December.

‘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.’

January 1968

‘There are three main developments that could conceivably moderate the inflationary impetus. First, the possibility of a cessation in US bombing and the beginning of peace negotiations in Vietnam. Second, we might really get a substantial measure of fiscal restraint this year, including a tax increase in the spring and a continued hold-back by the Administration on expenditures. Third, financial conditions are now taut enough.’ – John Charles Partee, Board Economist

‘The financial markets appeared to have taken the Committee’s latest tightening moves in stride. The expressions of the US determination to defend the dollar could produce a sobering effect on business expectations and hence help dampen inflationary psychology.’ – Edward Wayne, President, Federal Reserve Bank of Richmond

March 1968

‘Prospective developments [are] based on the unhappy circumstance in which principal reliance is once again placed on monetary restraint to curb inflationary forces.’ – Daniel Brill, Board Economist

‘Given the dangerous inflationary tendencies, the very gloomy payments outlook, and the recent excessive pace of bank credit expansion, there is a strong case for a further change in monetary policy toward greater restraint.’ – Alfred Hayes, President, Federal Reserve Bank of New York

‘The US is moving toward a serious and perhaps critical juncture of destabilising forces. Wage-cost-price pressures are increasing. The large prospective budget deficit is growing. Domestic inflation in gaining strength… Monetary policy could, and must, be more restrictive.’ – Philip Coldwell, President, Federal Reserve Bank of Dallas

‘There is no assurance that price inflation is being restrained. Rather indications are that the rate of price inflation probably would accelerate. Virtually all manpower with qualifications sought in the labour market was employed. Combined military and civilian demand has created a scarcity of manpower.’ – George Clay, President, Federal Reserve Bank of Kansas City

‘For about six months, the members of the Committee have agreed that containing inflation should be the goal of monetary policy. The Committee changed its policy directive three months ago, and the inflationary pressures which led the Committee to that decision have not abated.’ – Darryl Francis, President, Federal Reserve Bank of St. Louis

‘It is the unanimous view of the members today that greater monetary restraint is desirable. However, there are problems of timing. I am not prepared to advocate an increase in the discount rate of either one-quarter or one-half of a percentage point. I want to increase restraint gradually and unaggressively.’ – William McChesney Martin, Chair, Board of Governors

‘I am pessimistic about getting help in resisting inflation from either a tax increase or a cut in government expenditures.’

April 1968

‘I am pessimistic about getting help in resisting inflation from either a tax increase or a cut in government expenditures. Recently, the System has taken a series of actions designed to reduce the rate of monetary expansion…The System should quickly take another step toward restraint.’ – Darryl Francis, President, Federal Reserve Bank of St. Louis

‘Businessmen’s inflationary expectations are building in imbalances which will result in a painful correction at some time.’

October 1968

‘The unemployment rate could rise to 4.5% by mid-1969, and average 4% or thereabouts for fiscal 1969. That makes it logical to assume that inflationary pressures are likely to become less intense. An unaltered Committee policy is appropriate.’ – Hugh Galusha, President, Federal Reserve Bank of Minneapolis

‘Framing monetary policy is particularly difficult because of the problem of reconciling anticipations of economic weakness with the actualities of immediate economic strength.’ – Karl Bopp, President, Federal Reserve Bank of Philadelphia

‘We have moved from exceptionally rapid growth to less hectic economic expansion. What is still in doubt is the extent of the slowdown and whether it will be of sufficient depth and duration to reduce inflationary pressures significantly.’ – Murray Wernick, Board Economist

‘We have hardly made even a start toward the much-hoped for slackening in upward price and wage pressures. Inflationary psychology has a pretty strong hold.’ – Alfred Hayes, President, Federal Reserve Bank of New York

‘Creation of monetary assets during the past 20 months at a rate significantly faster than the productivity growth has led to excess demand for goods and services. The result had been inflation.’ – Darryl Francis, President, Federal Reserve Bank of St. Louis

‘It would be asking too much of monetary policy to expect it to deal with the inflationary psychology resulting from the cumulated heritage of past failures of public policy.’

November 1968

‘Convincing evidence of an economic slowdown is still lacking, and the outlook remains stronger than would seem desirable. The labour market remains very tight. There has been no let-up in price pressures; the October rise in wholesale industrial prices was disturbingly large. The outlook perhaps is for some further moderate slowing of the economy in the current quarter and the first half of 1969. Many economists are thinking, however, in terms of a substantial speed-up after the first half of next year.’ – Alfred Hayes, President, Federal Reserve Bank of New York

‘My confidence that the fiscal package would succeed in dampening inflationary trends sufficiently without additional help from monetary policy has been weakened.’ – Frank Morris, President, Federal Reserve Bank of Boston

‘Positive, forceful action is needed promptly to stem the tide of inflation for both domestic and international reasons.’ – Philip Coldwell, President, Federal Reserve Bank of Dallas

‘For the System to deal effectively with the prevailing inflationary psychology it would have to make a dramatic move – perhaps a one-half point increase in the discount rate. I would not be prepared to take such action.’ – George Mitchell, Board of Governors

‘Members of the Committee, including myself, and the staff, have underestimated the strength of the economy. While there are some signs of a slowing, this is much less than expected. But policy should not be firmed now. It would be asking too much of monetary policy to expect it to deal with the inflationary psychology resulting from the cumulated heritage of past failures of public policy.’ – William McChesney Martin, Chair, Board of Governors

‘The US should be raising defences against a coming crisis.’

December 1968

‘On the basis of some international telephone conversations this morning I concluded that a quarter point increase in the discount rate would not cause concern, but that a larger discount rate increase would cause serious concern.’ – James Robertson, Vice-Chair, Board of Governors

‘Based on recent discussions I have the impression that a small increase in the Federal Reserve discount rate would not have serious consequences for sterling. The possible implications of more overt action are extremely difficult to evaluate.’ – Alfred Hayes, President, Federal Reserve Bank of New York

‘The US should be raising defences against a coming crisis. One way – essential in the long run – is to slow our inflation and thereby improve the current account. It is hard to see other immediate possibilities.’ – A.B. Hersey, Board Economist

‘Inflation is continuing at a 4% annual rate, and expectations of future inflation appeared to be heightening… There seems little question that a restrictive monetary policy has to be pursued to provide the necessary total restraint to end the inflation.’ – Darryl Francis, President, Federal Reserve Bank of St. Louis

‘I recommended an increase of half a percentage point [in the discount rate] to give clear notice to the market of the Federal Reserve’s intention to restrain the growth of money and credit.’ – Karl Bopp, President, Federal Reserve Bank of Philadelphia

‘The incoming administration probably would be inclined in the direction of economic restraint. If the System was to take action to deal with the existing inflationary psychology, the present moment might offer almost the last chance.’ – George Mitchell, Board of Governors

Phase 6 – 1969
Acquiescence: Martin’s apologia

Discount rate raised from 5.5% to 6% 4 April 1969

‘I informed them [Johnson and Nixon] that the reduction of the discount rate to 5.25% in August turned out to have been based on a miscalculation.’

January 1969

‘Inflationary forces are strong, and most sectors of the economy are vigorous. Wholesale prices have continued their renewed advance… We have got a good reaction so far to our policy moves, but there is still a long way to go.’– William Treiber, First Vice-President, Federal Reserve Bank of New York

‘The toughest part of our job lies ahead. That consists of sticking to a tight policy with determination until the economy has been set decisively on the track of a slower and non-inflationary expansion.’ – James Robertson, Vice-Chair, Board of Governors

Lyndon B. Johnson, left and right, Richard Nixon. Pictures©Library of Congress Prints & Photographs Division

‘I have been in communication with President Johnson and President-elect Nixon (pictured) and appropriate associates. I informed them prior to mid-December of the general view within the Federal Reserve that the reduction of the discount rate to 5.25% in August turned out to have been based on a miscalculation, and that the rate should shortly be increased to the previous level of 5.5% or perhaps to 5.75%. To Mr Nixon I expressed the view that inflation was the primary economic problem now facing the nation, and that the new Administration would have to deal with it effectively from the beginning. The System continues to face the problem of dealing with the “heritage of errors” from past economic policies.’ – William McChesney Martin, Chair, Board of Governors

February 1969

‘The non-financial economy is one in which, hopefully, stabilisation policies succeed in cooling off inflationary expectations relatively soon, with fiscal restraint biting into the economy in this half year, increasingly reinforced by a degree of monetary restraint. Accomplishing all this will not be easy, given we have been running with overheated conditions.’ – Daniel Brill, Board Economist

‘The main concern is that a short period of excessive monetary restraint would be followed by a period of excessive monetary ease, on the pattern of 1966-68. If that should happen, long-run inflationary psychology might become more deeply rooted.’ – Frank Morris, President, Federal Reserve Bank of Boston

‘While some financial indicators show signs of being affected by our actions, there are other measures that are still very buoyant. Total bank funds loaned to businesses continue to run high, fuelling corporate outlays that are adding to inflationary troubles.’ – James Robertson, Vice-Chair, Board of Governors

‘Nothing must happen that would result in recession or even in much increase in unemployment.’

April 1969

‘The strength of the economy and the prevailing inflationary psychology counsel some visible evidence of a modest tightening of credit policy. An increase in the discount rate from 5.5% to 6% would provide such evidence and would bring it into better alignment with market rates.’ – William Treiber, First Vice-President, Federal Reserve Bank of New York

‘The national economy continues to expand beyond earlier expectations and beyond the growth in available resources, notably manpower, and prices exhibit a strong inflationary trend… A clear agreement on peace [in Vietnam] would moderate inflationary expectations.’ – George Clay, President, Federal Reserve Bank of Kansas City

‘The primary problem is inflationary psychology. There are many signs indicating that inflation was becoming a way of life in the nation today. Policy-makers have to come to grips with the problem.’ – William McChesney Martin, Chair, Board of Governors

‘Our inflationary problem is stubborn and persistent.’ – Daniel Brill, Board Economist

‘The System was overly hasty in moving toward ease.’

July 1969

‘For those searching for signs that the slowdown in the economy has become visible, these have been trying days. But it still seems highly probable that by the turn of the year real GNP will be growing very little, if at all.’ – Murray Wernick, Board Economist

‘Business activity has great vitality after an unprecedented 100 months of sustained expansion… Recent wage increases written into collective bargaining agreements add significantly to strong cost-push pressures.’ – William Treiber, First Vice-President, Federal Reserve Bank of New York

‘I am deeply concerned about the outlook for the surtax extension bill; there is a real possibility that it will not be enacted. The Committee should call for holding as closely as feasible to the present degree of pressure. It would be a mistake to take any action that might reinforce inflationary expectations. The System was overly hasty in moving toward ease in the summer of 1968, in part because of faulty judgments but also because of faulty projections.’ – William McChesney Martin, Chair, Board of Governors

October 1969

‘It is much too soon to gauge the extent of any slowdown, the real question being whether the slowdown will be substantial enough, and of sufficient duration, to bring a significant drop in the rates of price and wage increases.’ – Alfred Hayes, President, Federal Reserve Bank of New York

‘The Committee’s policy in the first half of 1969 was less restrictive than intended. It was only recently that the desired degree of restraint has been achieved and it would be a mistake to back off now.’ – William McChesney Martin, Chair, Board of Governors

December 1969

‘Policy has made substantial progress toward assuring a less exuberant economic environment and one which holds promise of a moderation in currently pervasive cost and price pressures.’ – Murray Wernick, Board Economist

‘There are real grounds for doubt whether the slowing will be big enough or long-lasting enough to bring a significant braking of inflation. Some are inclined to draw the conclusion that inflation is inevitable; but there are a growing number who seem to be looking toward the possibility of wage and price controls as the only answer.’ – Alfred Hayes, President, Federal Reserve Bank of New York

David Marsh is Chairman of OMFIF.