 | The Cavalier daily Tuesday, October 12, 1971 |  |
Economic Disaster
I disagree, although I will
readily admit that there has been
almost a one-to-one correspondence
in the past between major inflations
and wars. I am also willing to
concede that some relatively minor
inflation was likely in 1966, given
the excessive fiscal stimulation of
1964-65. Unfortunately, however,
monetary policy decisions by the
Federal Reserve authorities (Fed.)
converted an already tricky
situation into an economic disaster.
During late 1965 and early 1966
the Fed permitted the nation's
money supply to grow at rates far
in excess of the economy's ability
to expand real output. As one
would expect, upward pressures on
prices became very strong and
widespread.
Now the men who set Federal
Reserve policies are neither evil nor
stupid, so the questions arise, "Did
they have a choice? Could they
have prevented what everyone now
recognizes was grossly excessive
monetary growth in 1965-66?" The
answers, I believe, are clearly "yes."
The Fed has adequate powers to
prevent excessive monetary growth.
The reason they failed to use these
powers seems to be that their
actions were being guided by an
incorrect theory of how monetary
policy works. Apparently they were
misled, as they have been on many
occasions both before and since
1965, by the fact that interest rates
were rising quite rapidly and had
reached what at that time seemed
dramatic levels by early 1966. The
Fed believed, in orthodox
Keynesian fashion, that it could
check the interest rate rises by
making money and credit more
plentiful. It is now clear that this
policy was self-defeating: rapid
monetary expansion was the cause
of the interest rate rise, as lenders
demanded compensation through
higher rates for the inflation that
they foresaw in the months and
years ahead.
At any rate, by early 1966 it
was obvious to everyone that the
economy had strayed seriously
from the stable growth path it had
been following in the early 1960s
The Fed responded by throwing its
money machine into reverse
between April and October 1966.
Not surprisingly the inflation soon
began to abate. However, credit
market do not easily adjust to such
rough tactics and by August 1966
the famous "credit crunch" was in
full swing. Faced with what it
believed to be the beginnings of an
old-fashioned liquidity crisis, as in
1893 or 1907, the Fed started the
money machine rolling forward
once more—again at a rate that
would certainly be untenable for
any prolonged period.
The Federal Reserve narrowly
averted a recession in 1966-67, but
only at a cost of propelling the
economy forward again at an
inflationary rate. As interest rates
skyrocketed in 1968 and 1969 the
Fed persisted in its permissive
monetary policy, fearful of
inducing another credit crunch.
When Congress finally got around
to raising income taxes(temporarily)
in June 1968, economists at the
Fed began to cry out in anguish
in the potency of fiscal policy was
so strong that they expected the
tax increase to produce a recession.
So excessive monetary growth
continued and was rationalized as a
needed antidote to the "overdose"
of fiscal medicine. Meanwhile,
inflation was accelerating, reaching
six percent plus rates in late 1968.
Finally, early in 1969 the Fed
screwed up its courage and
slammed on the monetary brakes
once more. This time it slowed the
economy enough to generate a
classical business recession,
beginning in November 1969. The
recession turned out to be the
mildest ever recorded—so mild that
it was almost over before
economists could agree that there
had been one at all. The overall
unemployment rate never exceeded
6.2 percent compared with levels of
7.5 percent and 7.1 percent in the
recessions of 1957-1958 and
1960-61. Indeed, if one looks at the
more meaningful unemployments
rate for married males only, one
finds that the 1970 levels were not
much higher than those of most
prosperous years of the past.
Similarly, the decline in production
was very slight. By the end of 1970
the recession was over, and a steady
though hardly vigorous recovery
has been under way since then. It is
reasonable to suppose that the
economy will be back at "full
employment" sometime in the
next couple of years.
| The Cavalier daily Tuesday, October 12, 1971 | |