Bernanke and Burns: Right in the mainstream
When Arthur Burns was named to head the Federal Reserve Board in 1970, the Great Inflation was already underway. But when he left in 1978 the inflation problem had become even worse. Indeed he presided over some of the most inept Fed policy of the entire 20th century. Here’s Athanasios Orphanides discussing Burn’s views as an academic:
In his 1957 lectures on Prosperity Without Inflation, Arthur Burns eloquently explained that economic policies since the enactment of the Employment Act of 1946 had introduced an inflationary bias in the U.S. economy which had marred our nation’s prosperity in the post-war period” (p. v). By promoting maximum employment,” the Act encouraged stimulative policies which, by prolonging expansions and checking contractions, resulted in an upward drift in prices. Burns called for an amendment to the Act, a declaration by the Congress that it is the continuing policy of the federal government to promote reasonable stability of the consumer price level” (p. 71).
And here’s Lawrence White discussing how Burn’s views evolved after being named to the Fed:
In his Newsweek column of 2 February 1970, Milton Friedman enthusiastically cheered the previous week’s appointment of his former college professor and mentor Arthur Burns as Chairman of the Board of Governors of the Federal Reserve System. He lauded Burns as the first person ever named Chairman of the Board who has the right qualifications for that post. Under Burns’s predecessor, the United States inflation rate had reached 5.5 percent in 1969, rising from only 1.2 percent in 1962. Friedman’s research had convinced him that inflation””persistently rising money prices of goods on average””was due to overly rapid growth in the stock of money, more dollars chasing each bundle of goods. As head of the central bank Burns would be in position to control the quantity of money in the American economy. Friedman encouraged Burns to produce growth in the money stock”•low enough to avoid renewed inflation.”–1
In only a few months Friedman had to choose between keeping his convictions and keeping friendship with Burns unimpaired. As Fed chairman Burns began attributing the inflation he had inherited not to previous monetary policy, but to cost-push factors beyond the central bank’s control. In July 1971 Burns told a congressional hearing: The rules of economics are not working in quite the way they used to. Despite extensive unemployment in our country, wage rate increases have not moderated. Despite much idle industrial capacity, commodity prices continue to rise rapidly. He called for federal wage and price controls to fight this supposedly new type of inflation””a policy response that in Friedman’s view was akin to fighting a Toyota’s runaway acceleration by taping down its speedometer needle.
In May 1970 Friedman sent Burns a lengthy handwritten letter criticizing Burns’s arguments and policy proposals. Edward Nelson relates that Burns was shaken by the letter and personal relations between the two deteriorated.2 The disagreement went public as Friedman in lectures, newspaper interviews, and writings challenged Burns’ views. At the December 1971 meetings of the American Economic Association, Friedman quoted and rebutted Burns’ July statement. Examining the data, Friedman found that inflation was in fact responding as usual to money growth. The economy was performing poorly because the Fed under Burns was pursuing erratic and destabilizing monetary policy [that] has largely resulted from the acceptance of erroneous economic theories.”–3 A sharper rebuke by a student of his former teacher, consistent with professional decorum, is hard to imagine.
As with Friedman and Burns, Bernanke was my first choice to head the Fed. As with Friedman and Burns, I was disappointed to see Bernanke adopt the sort of passive policies he criticized the BOJ for pursuing. As with Burns, Bernanke is following a policy close to what the “median economist” would prefer. Some economists would prefer easier money, some tighter, but Bernanke is certainly right in the mainstream. So was Burns.
Over the last few years I’ve occasionally argued that macroeconomists as a class are mostly to blame for the global economic crisis, not bankers or regulators. Seeing what happened under Burns makes me even more convinced that we macroeconomists are to blame.
What does this tell us? It tells us that it may not matter than much who’s in charge of the Fed, rather it depends what the median economist thinks is the appropriate policy. As an analogy, domestic economic policy probably reflects the views of the median Congressman more than the views of the President.
PS. Bryan Caplan has two good posts on Larry Ball’s paper on Bernanke (here and here.) Caplan studied under Bernanke.
HT. Thanks to the commenter Declan, who pointed out the connection between Burns and Bernanke.
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18. February 2012 at 13:42
Interesting commentary. However, my guess would be that Volcker did not preside over a consensus view, but was strong-willed.
Add on: We see that the problems faced by earlier central bankers were in some ways more daunting than what Bernanke faces. Bernanke rally does not have an excuse for his excessive timidity.
Sheesh, Volcker had inflation in high single to double digits. Other guys (Burns) faced a largely domestic economy and much more unionized workforce. Bernanke has a globalized economy (less inflation due to competition) and largely de-unionized workforce.
Bernanke has inflation nearly dead, and perhaps even deflation (the CPI may overstate inflation, and unit labor costs are falling).
Bernanke is just being way too feeble.
18. February 2012 at 13:45
Ben, I agree that Bernanke should do more, but I think we also need to focus the spotlight on the profession as a whole. If there was strong support among economists for him doing more, even a weak-willed leader would bend to that consensus.
18. February 2012 at 13:57
I have always suspected that Burns deliberately overstimulated the economy prior to the November 1972 in order to help reelect Nixon. This of course led to massive inflation after the election and the resulting recession as a result of fighting that inflation.
18. February 2012 at 15:07
Scott
You left out the best (in my view) account of Burns and Inflation. That´s the 1998 article by Bob Hetzel:
http://www.richmondfed.org/publications/research/economic_quarterly/1998/winter/pdf/hetzel.pdf
18. February 2012 at 15:47
WAIT.
If what matter matter is what the median economist thinks, we should remove the agency problem.
Why did Friedman want to runt he Fed with a computer?
Bigger is:
Last year some time I actually DREW this chart that Barclays has drawn:
http://modeledbehavior.com/2012/02/18/more-on-the-output-gap/
And Scott you demanded to know my reasoning and than waved it away – I gave same answer as Barclay – admit we were in bubble.
SO NOW:
Scott you look at that chart and any time growth goes over 4.5% NGDP you start pissing on growth so it stays at that thin light blue line… and that IS the Sumner agenda writ large.
I was RIGHT that the bubble argument had validity, and it took forever for someone else to draw the stupid line.
Don’t make me wait another damn year before you finally get pushed into a conversation about the brutality of a level targeted NGDP.
—-
It really is no wonder that people don’t talk about Keynes not giving public employees raises in good times…
Because even Sumner doesn’t want to talk about the flipside of his thinking.
It is FULLY 50% of f your theoretical construct and you never mention it.
That says something very weird about economists.
18. February 2012 at 16:00
http://newmonetarism.blogspot.com/2012/02/three-views-of-state-of-economy_12.html
18. February 2012 at 16:08
Scott-
Of course, you are right. The whole profession seems to have a “middle” of conventional thinkers, who have a powerful center of gravity.
Although I get the impression Volcker did not give a hoot what others thought.
But yes—the herding instinct to consensus is strong, whether right or wrong.
18. February 2012 at 16:15
Lots of food for thought here:
Is it better to have:
1) Policy determined by the idiosyncratic views of an intelligent strong-willed leader (Bernanke, Trichet, Monti, etc.)
2) Policy determined by the consensus of economists
I vote for 2 despite the obvious “rhinoceros” problem. At least there is some stability around which we can plan. I cringe when I read reports that Monti “gets it” and is fixing Trichet’s mistakes. Does that imply that if Monti were replaced by Weidmann Europe would immediately go down a rat hole? Or if Bernanke is replaced in 2014 the US is in trouble?
Also, does the power of the “consensus of economists” imply that folks like Rupert Murdoch are actually the most powerful setters of monetary policy, by selecting the WSJ columnists read by all the wall street macro crowd?
18. February 2012 at 16:15
One more fcr the home team:
http://soberlook.com/2012/02/flaws-in-cbos-output-gap-measure.html
Scott you REALLY ought to note now….
Take the charts on these posts – we’re at near manufacturing avg. etc. and CENTER that avg. performance at your 4.5% level target. then remove everything above or below it – like your policy would do.
Your own monetary policy draws the same line as Barclays!
So instead of saying we’ll never get back the missing 12% or whatever, ADMIT we’re only a couple points off and use 4.5% as the proof point.
You can make a ar more politically viable argument for NGDP if sooner rather than NEVER your policy will say RAISE FRIGGIN RATES, and people know that time is coming.
18. February 2012 at 17:22
And like some in the present day Fed, Burns tried to explain (with plenty of frustration no doubt) that economic circumstances seemed to be affecting realities outside the control of the Fed. How different might an essentially brand new service economy be – inflation wise – than the ‘planned’ inflations of war? (The same service economy which some believe kept us out of depression this time)
18. February 2012 at 17:44
Take Burns, Volcker, Greenspan and Bernanke. Admittedly, It´s a small sample but there´s a neat separation along the Academic – Non Academic divide, with the successful ones, Volcker and Bernanke in the Non Academic group and the two unsuccessful deeply inside the Academic group. Also, along the same divide, it seems that Volcker-Greenspan were much more forceful leaders than B&B, maybe because they had “survival training” in a less “hospitable” (i.e. non academic) environment.
18. February 2012 at 19:10
Richard A. You are correct.
Marcus, Yes, Hetzel’s always excellent.
Morgan, Anyone can draw lines, but the evidence suggests the Fed was aiming for about 5%. Given that fact, 2008 was a horrible time to set a new trend. If they had been aiming at 4.5% then I’d agree with you.
Ben, Yes, but also remember that Volcker actually reduced inflation faster than he intended.
Steve, Or perhaps we should let the market set policy, using NGDP futures contracts.
Becky, Yes, and recall that Bernanke said monetary policy was not a “panacea.”
Marcus, Good point, although I suspect Greenspan might have been unsuccessful if he had hung on a few more years. His post-2006 statements haven’t inspired confidence.
18. February 2012 at 19:23
What we need is a consistent poll of macroeconomists.
Then we can dispense with the silly fed statements.
18. February 2012 at 20:02
Scott – What do you say to the criticism that stable NGDP (and thus low macroeconomic volatility) potentially encourages excess leverage. There was a large buildup of household debt during the 1990-2007 period of stable 5% NGDP growth.
18. February 2012 at 21:39
Scott, How do you square aiming for 5% and “opportunistic disinflation”?
My larger point Tommy gets too.
2% inflation is the most that’s acceptable on trend, the mistake was assuming 3% was real from 2000 on.
18. February 2012 at 23:58
So I’m confused. Is it Scott or Bryan who is the new Milton?
18. February 2012 at 23:59
This is the type of drivel coming out of mainstream macroeconomics today: http://tinyurl.com/7tqr8ut
I think Scott is absolutely correct. Instead of wringing our hands at the economic illiteracy of the masses, we first sadly need to focus on improving the economic literacy of our economists.
Recently, I have taken a break from Scott’s site and the whole market monetarist blogosphere just to see if anything has changed out there in the mainstream. And I am sad to report that nothing has. On the right, it’s the same old argument that companies and people aren’t spending because we have a Kenyan Nazi socialist as a President. And on the left, it’s people aren’t spending because we are not forcing companies to pay them enough so that they can spend. I have spent so much time engrossed in the market monetarist blogosphere that I felt like we actually are having some impact. But once you peek your head back out into the mainstream, we are barely causing a ripple. When I bring up NGDP targeting in comment threads, I get the worst response: nothing. No rants against me, just deafening silence.
Of course the good news is that we don’t have to convince the masses. As Scott points out, we just have to convince the average macroeconomist. So keep on blogging and keep up the good work Scott.
19. February 2012 at 05:47
It takes Scott and Bryan to make Milton.
19. February 2012 at 05:49
Liberal Roman,
This is EXACTLY why I say Scott needs to admit the far-right conservative economic outcomes of his policy.
Right now all he does is try to convince liberals.
Until he admits what it is in full, it won’t happen.
19. February 2012 at 06:11
DW, We need to take monetary policy away from macroeconomists and give it to the market.
Tommy, It’s like saying drivers should get into a car accident once a year so they don’t get overconfident. I regard it as a crazy theory. If NGDP growth is stable, it doesn’t hurt the economy if there is over-leverage.
Leverage problems should be dealt with (if at all) through regulation, not monetary policy.
Morgan. Opportunistic disinflation is an insane idea. I can’t believe that sensible economists were drawn to it.
PrometheeFeu. No one can replace Milton. He knew more macro than I do, and as much micro as Bryan does.
Liberal Roman. Great comment.
19. February 2012 at 11:54
@Scott – Leverage problems should be dealt with (if at all) through regulation, not monetary policy.
No they should be one and the same. Let the Fed flexibly set min and max asset/equity ratio for banks.
Separately, regarding Bernanke behavior, I think you fail to consider two important potential explanations: a) his political views/objectives and b) the reality of how politics/governance actually works. Neither Bernanke nor the Fed is an island. Personality aside, the nature of any form of governance puts hard constraints on outcome.
Regarding leverage – all else being equal, it is a function of expected after tax returns and it largely determines potential RGDP growth rates, from which it follows that the Bush tax cuts on capital and the Fed’s TBTF policy engendered higher RGDP growth potential. And.. because economists have not factored into account asymmetric returns on capital, they totally miscalculate the shape of the Laffer curve and grossly underestimate the impact of capital tax rates on GDP growth.
@Morgan – It seems to me, you can figure out if you have NDGP pegged right by looking at the delta between N and R GDP… or maybe by looking at V.
19. February 2012 at 13:00
“Opportunistic disinflation is an insane idea. I can’t believe that sensible economists were drawn to it.”
Scott, thank you are ADMITTING they were not targeting 5%.
Jesus, I have to work so hard.
now that you admit they were not targeting 5%, can you please admit that the line should be drawn admitting they were not targeting 5%.
I know logic offends you sometimes, but it helps those of us who actually want to make your arguments stronger.
19. February 2012 at 19:16
Scott,
I’ll be brutally frank. Once you get admitted to the College of Cardinals (the FOMC) they generally try (and usually succeed) to shear your balls off.
What we need is a man who doesn’t let that happen (ironically someone like Greenspan).
P.S. If you feel the need to eliminate this comment I’ll totally understand.
20. February 2012 at 05:01
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20. February 2012 at 07:20
Re: Bernanke’s “conversion into a median macroeconomist”
We sometimes forget that people who accept political appointments (e.g.to the Fed Board of Governors)tend to be politically ambitious. If we hypothesize that Bernanke’s ambition was to be eventually appointed Fed Chairman then his abandonment of the views he held as an academic economist is perfectly understandable.
Had he espoused his academic views after his initial appointment to the board he would have been seen as a minority of one, a trouble maker, and not a team player. This would have ended any chance he had to become Fed Chairman.
So instead he morphed into the “median macroeconomist” as far as his votes and arguments to the board went. He wanted to lead the Fed parade, and his early years on the board were devoted to catching up to the head of that parade so he would be awarded the drum major’s baton. This phenomenon is widely recognized among organization theorists as “organizational capture” of its members. Not the same phenomenon as “group think” but with the same results.
Sadly, this illustrates the wisdom of the old proverb, here applied to Bernanke’s Fed appointment: ” be careful what you wish for – you may get it”.
20. February 2012 at 08:18
Carl,
I referred to this feature of governance in my post as well. I’m not sure it’s a fault of the system. Montesquieu would certainly have seen it as a virtue as would the Germanic tribes who had this stuff figured out 1500 years ago before they moved to England.
20. February 2012 at 08:40
The idea that policy is the result of the median economist or congressman makes some sense. Often leaders and excutives seek the meidan position which they call the Center. Berannke is a centrist not as hawkish as the hawks nor as dovish as the doves.
It’s for that reason liberals in more recent years have looked back almost nostalgically to Nixon-he looks so much more liberal than anything we’ve seen since though this a more liberal age.
20. February 2012 at 08:41
That last sentence should read “that was a more liberal age.” the age being Nixons age as opposed to our own.
20. February 2012 at 11:01
dtoh, You said;
“No they should be one and the same. Let the Fed flexibly set min and max asset/equity ratio for banks.”
1. I consider that regulation, not monetary policy.
2. They still need to do monetary policy, as those sorts of regs don’t pin down the price level.
RGDP growth under Bush wasn’t very high, even before 2008.
I completely agree with your comments about political pressure playing a role, certainly with Burns, and to some extent with Bernanke. But Bernanke was also affected by the internal politics in the Fed. Every institution has a way of doing things, and that’s hard to change.
Morgan, I think they were implicitly aiming for roughly 5%, but were not explicitly targeting NGDP. It’s possible that trend growth has fallen below 5%, and thet may be part of the current problem.
Mark, Dare I say Krugman and DeLong on the Fed? They’d be hard to push around.
Carl, Good point.
Carl and dtoh, It may be good that the Fed represents the median economist, and not me. The problem isn’t the Fed, it’s the opinions of the median economist.
Mike Sax, I agree–although it depends which issue one focuses on. Nixon wasn’t liberal on Vietnam or gay rights.
20. February 2012 at 12:40
Scott, I think you’re wrong.
You said,
“They still need to do monetary policy, as those sorts of regs [setting min and max asset/equity ratio for banks] don’t pin down the price level.”
No they would not need separate monetary policy. If the Fed can flexibly regulate both MINIMUM as well as maximum bank asset/equity ratios by asset class, they would have much more control of the monetary aggregates, asset prices, and monetary policy than they do with the dull tools they are currently using. Think about it. THIS SHOULD BE OBVIOUS.
20. February 2012 at 16:05
Mark S,
If you are still following this thread, I have seen cows graze here: http://g.co/maps/x5yay
20. February 2012 at 19:12
dtoh, No you can’t pin down the price level with regs. Take any regulatory regime you like, and increase the monetary base 100 fold. The price level will rise 100 fold, even with no change in capital ratios. It’s the neutrality of money you are overlooking.
20. February 2012 at 22:23
Scott,
Why do you even need the monetary base. It would be easy to run the system letting private banks issue currency (or electronic money cards) and have the banks settle directly with one another without the use of FF. As long as the monetary authority has control over leverage, they can control how much currency is issued and the stock of M1, etc.
Looked at another way, suppose you hold the base constant. If you can nevertheless force the banks to increase their lending, you get an instant increase in M1 and the price level.
It’s no different than when the Fed increased the base, and then sanitized it by paying interest on excess reserves. It had no impact on NDGP or the price level. You just do it in reverse, hold constant the base and tell the banks they have to increase their leverage. You could even increase the price level while decreasing the base.
21. February 2012 at 18:21
dtoh, You are mixing up several issues. I agree they can control the price level to some degree via changes in the demand for money, but they still need to control the base (as IOR doesn’t apply to currency.)
Private currency is very different, and you’d need to spell out the medium of account in detail. What would private currency be redeemable into?
21. February 2012 at 20:55
Scott,
What is Fed currency redeemable into? Just make private currency (from Fed regulated banks) legal tender for all transactions. You could call it a Fed Approved Note.
But I am not suggesting that you need to get rid of the Fed as the issuer of currency or the clearing house for interbank transactions. What I am saying is that currently the Fed induces banks to buy more assets (including making more loans) either by buying up existing assets from the banks or by making it cheaper for the banks to borrow from the Fed. This also causes an increase in the various monetary aggregates. This kinds of works… but it would be much better to simply command the banks to buy more assets. You can easily do this if you can flexibly regulate maximum and minimum asset/equity ratios by asset class.
MB has some impact on MV/NDGP but MB is not the only money be using used for transactions, which is why MB can go way up while MV goes down or stays flat. On the other hand if the Fed had a tool to directly make M1 go up it would definitely make NDGP go up. Not only would this be more effective, it would get rid of the silly arguments about the ineffectiveness of monetary policy at the ZLB and the dangers of the government “printing money.”
23. February 2012 at 19:39
dtoh, Yes, Fed currency is not redeemable into anything, but then they aren’t a profit-maximizing bank. If they were we’d have hyperinflation.
24. February 2012 at 17:49
So regulate the banks’ with asset/equity ratio rules. If you need to, tack on a rule limiting how much currency they can issue relative to equity (or assets).. better yet require them to issue it as electronic money and make them pay a statutory interest rate on it. Politically TBTF won’t go away so you have to regulate the banks anyway.
This had gotten off on a tangential track… the real point is that the Fed should be regulating asset/equity ratios in order to control the size of the broader monetary aggregates. They can keep their interbank clearinghouse function and currency issuing function while still doing.
7. June 2012 at 05:27
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