Politics & Policy

Warriors Against Inflation

Volcker and Reagan got the job done.

One of the amusing things about the liberal media is its compulsion to always present an alternative perspective to conservative successes, even when it looks ridiculous doing so. Only liberal successes are allowed to be presented without some reporter saying, “On the other hand….” Thus, reports of Ronald Reagan’s accomplishments are always accompanied by boilerplate about his alleged failures, whether it was his inability to cure AIDS, the Iran-Contra scandal, or something else.

Unfortunately, even conservatives sometimes fall victim to this compulsion. Two areas where this often occurs are inflation and the deficit. It is said that Paul Volcker, former chairman of the Federal Reserve, deserves all the credit for eliminating inflation, with Reagan some kind of passive observer. It is also said that large budget deficits prove that Reagan’s economic policy was a failure. Both perspectives are seriously misinformed.

It is true that inflation is fundamentally a monetary phenomenon. The inflation of the 1970s came about primarily because Fed chairman Arthur Burns gunned the money supply to get Richard Nixon re-elected in 1972. He was followed by G. William Miller, appointed by Jimmy Carter. Miller didn’t have a clue about monetary policy and only made the dismal inflation situation he inherited far worse.

The consumer price index, which rose 4.9 percent in 1976, the year Carter was elected, jumped steadily to 6.7 percent in 1977, 9 percent in 1978, and 13.3 percent in 1979. At this point, Carter realized that he had made a serious error appointing Miller to the Fed. But he could not be fired, so Miller had to be induced to leave voluntarily. Consequently, Carter fired Treasury Secretary W. Michael Blumenthal, who had been doing a fine job, in order to open the position for Miller, who left the Fed to replace him.

Under pressure from Wall Street, Carter reluctantly appointed Paul Volcker to be chairman of the Federal Reserve Board in 1979. Volcker had been under secretary of the Treasury for Richard Nixon and was then serving as president of the Federal Reserve Bank of New York. However, it is naïve to think that Volcker was given a free hand by Carter. His inability to fully implement a tight-money policy is why the inflation rate fell only to 12.5 percent in 1980, despite a sharp recession that year.

It was only after the election, when Volcker knew that Carter had lost, that he really clamped down on the money supply. This illustrates an important point: Presidents get the Fed policy they want, no matter how “independent” the Fed may be. If there had been any doubt about this, it was settled in 1967, when Fed chairman William McChesney Martin buckled under pressure from Lyndon Johnson and eased monetary policy even though Martin knew he should have tightened it. This caused inflation to jump from 3 percent in 1967 to 4.7 percent in 1968 and 6.2 percent in 1969.

It is not now remembered how much pressure there was on Reagan to get rid of Volcker and have the Fed run a more accommodative monetary policy. Yet he not only supported Volcker publicly, he appointed like-minded people to the Fed whenever he had the chance. He reappointed Volcker to the chairmanship in 1983 and appointed Alan Greenspan to replace him in 1987.

The result of the Fed’s tight-money policy was a far faster reduction in inflation than most economists thought feasible. From 12.5 percent in 1980, it fell to 8.9 percent in 1981, and 3.8 percent in 1982. It is hard to explain just how remarkable this achievement was. Most economists would have considered it impossible in 1980, especially given the big 1981 tax cut, which was generally viewed as pouring gasoline on the fire of inflation by economists schooled in Keynesian economics.

But Reagan was firm in his belief that the money supply — and only the money supply — fundamentally determined the inflation rate. However, he also knew that other policies could ease the transition to a low-inflation economy. Toward this end, Reagan cut tax rates and reduced business regulation to increase the production of goods and services; deregulated the price of oil, which broke the OPEC oil cartel; and fired striking air-traffic controllers, which helped get the wage-price spiral under control.

Ironically, the far greater success of bringing down inflation is what really created the deficit problem. High inflation had pushed people into higher tax brackets, which had caused federal revenues to rise automatically. But low inflation eliminated this bracket creep. This factor alone added $41 billion to the deficit in 1981 and $64 billion in 1982, according to Office of Management and Budget.

Breaking the back of inflation was an enormous accomplishment. Reagan deserves much of the credit. Larger budget deficits were an unavoidable consequence.

– Bruce Bartlett is senior fellow for the National Center for Policy Analysis. Write to him here.

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