They were submerged by both economic theory and practical politics. On the one hand, the Kennedy-Johnson economists— and most of the early Keynesians—regarded Federal Reserve policy finally eliminated. Likewise, the United States as part of the Bretton Woods agreement in 1944 pledged to redeem dollars for gold at $35 per ounce. This promise exerted slight influence on American policies in the 1950s and 1960s. President Nixon renounced it in 1971. (See pages 98-99 for details.)

(what we call "monetary policy") as playing a subordinate and supporting role to shifts in government taxes and spending (what we call "fiscal policy"). Although the two would work in tandem, monetary policy would take its cues from changes in fiscal policy. Implicitly, this discouraged and devalued independent thinking and action. What also discouraged independent action were the repeated efforts—all ultimately failures—to suppress inflation through various forms of voluntary and mandatory wage and price controls. Presidents Johnson, Nixon and Carter all tried this approach. The basic idea was simple: If wages and prices wouldn't stay down on their own, then they could be cajoled, pressured or ordered down. Whether intended or not, these efforts relieved the Federal Reserve of the prime responsibility for preventing or reversing inflation.

Controls' failure should have surprised no one. In a complex economy—and a democratic society—it is difficult to devise rules that cover all situations and simultaneously seem fair and practical. Controls have to be flexible enough to accommodate economic realities (some prices vary seasonally; imports can't be covered, and so forth) but not so flexible that they seem capricious. The dilemma: If exceptions to the controls aren't made, they may collapse economically (if some prices are set too low, for example, shortages will result); but too many exceptions may cause the controls to collapse politically. People see their wages or prices as fixed while those of others aren't. Feeling victimized or suspecting favoritism, they then defy or evade the controls. With dropping public support, controls need intrusive enforcement; but that seems heavy-handed—a police state—and invites a popular backlash.

Historically, the United States had resorted to compulsory con-

trois only in wars, notably World Wars I and II and the Korean War. In war, the problem is straightforward: The surge of military needs— for equipment, fuel, soldiers—requires that substantial production and labor be diverted from civilian to defense use. Somehow, government must outbid civilians to buy what it wants. The simplest way is to raise taxes and subtract directly from consumer purchasing power. Another way is to borrow heavily, raising interest rates and crowding out private borrowing. A final way is to print (or create) money—inflation. Because government spends the money first, it buys at lower prices; as the money circulates, consumer prices rise and living standards fall. Prices for scarce goods rise. Given these unpopular choices, government controls—rationing and limits on wages and prices—can be an attractive alternative. Government restricts civil production directly and holds down inflation by legal restrictions. In wartime, there's a clear political and moral rationale for controls, as economist Hugh Rockoff has noted. If prices alone allocate limited civilian goods, the heaviest burdens fall on the poor, because they can least afford the higher prices.14

In his Drastic Measures: A Study of Wage and Price Controls in the United States, Rockoff concluded that the controls worked reasonably well in both world wars. They restrained inflation without spawning massive inefficiencies or widespread public anger. The wars themselves explained this success. Patriotism counted. People tolerated restrictions and anomalies that, in peacetime, would have provoked outrage. In World War II, meat, gasoline, clothes, sugar, coffee and some other consumer goods were rationed. The War Production Board allocated industrial supplies—steel, copper, aluminum—to factories. Wages were controlled; unions renounced the right to strike. Still, some black markets, notably for meat, developed. Rent controls were sometimes evaded; to get scarce apartments, there were under-the-table payments. Some products were adulterated. Of twenty candy bars examined by Consumer Reports, nineteen shrank in size from 1939 to 1943; the disguised price increase was 23 percent. After the war, pent-up demand meant that the selective removal of price controls resulted in huge price increases. Freed from the no-strike pledge, unions sought to catch up with prices and capture what they saw as excessive profits. In 1946, strikes occurred in the auto, steel and coal industries, among others. By November, President Truman ended controls; without popular support, they were unworkable.15

The trouble with peacetime controls is that they face all the wartime vices without any of the wartime virtues. They are still complicated and cumbersome, but they lack patriotic props. The controls—voluntary and mandatory—of the 1960s and 1970s also had a fundamentally different purpose. It was not to reallocate production "fairly"; it was to maximize production and employment without the bother of inflation. To succeed, these controls required almost inhuman self-restraint—companies, workers and unions had to renounce their immediate self-interest in raising prices and wages while tolerating the mistakes, inconsistencies and absurdities of government regulations and bureaucrats.

The first precursor of controls emerged in the 1962 report of the Council of Economic Advisers, which advocated wage-price "guideposts." The focus was on unionized industries—steel, autos, airlines, trucking—usually dominated by a few firms. Unions (it was said) could exact big wage increases that companies could then pass along in higher prices. This market power could produce modest inflation even if the economy wasn't at "full employment." The guideposts aimed to "mobilize public opinion and government persuasion to bring wage and price decisions of high-powered labor and business units into closer conformity with competitive behavior," Walter Heller later wrote. Translation: The threat of bad publicity would substitute for genuine competition. In its 1964 report, the CEA fixed a number to the concept—3.2 percent. Businesses (the argument went) could raise wages 3.2 percent a year without raising prices. That represented estimated annual productivity growth. Greater efficiencies would cover the added labor costs without penalizing profits.16

President Johnson strove to enforce the guidelines. His delusion was that he could talk businesses and unions out of inflationary behavior so that the problem would just go away. "Jawboning" was the word used at the time, and Johnson was zealous at it. In 1965, the steelworkers and major steel companies—then a dominant industry—were close to an agreement that would have breached the guideposts. A flagrant violation would have rendered the guideposts meaningless. Johnson summoned the negotiators to Washington, provided his own mediators and insisted on wage increases within the guideposts and no price increases. When the negotiators capitulated, he announced his success live on all three major networks (ABC, CBS and NBC). Later, when Bethlehem Steel raised structural steel prices $5 a ton, Johnson attacked its executives as unpatriotic; they backed down. The episode "confirmed the belief in our minds and Johnson's that the President could get anyone to agree and that we could exert enormous influence over labor negotiations in the future," wrote his aide Joseph Califano.17

The confidence was misplaced. Even Johnson could not single-handedly persuade and bully the entire economy the way he had the U.S. Senate while majority leader. But he tried. For a while, he became America's firefighter in chief, rushing everywhere to douse inflationary flames. When aluminum companies raised prices in late 1965, he ordered the government to sell aluminum from its strategic stockpiles to break the increases. It did. When copper companies boosted prices later, he released more stockpiles, controlled exports and suspended an import duty. Informed that copper prices were set in world markets and that Chile was a major supplier, Johnson was undaunted. "Find out what will get [the president of Chile] to roll the price back," Johnson commanded. Ultimately, the U.S. copper companies rescinded their price increases. With hindsight, some of his forays seem almost comical. Califano recalled:

Shoe prices went up, so LBJ slapped export controls on hides to increase the supply of leather. Reports that color television sets would sell at high prices came across the wire. Johnson told me to ask RCA's David Sarnoff [RCA was then a major TV manufacturer] to hold them down. Domestic lamb prices rose. LBJ directed [Defense Secretary Robert] McNamara to buy cheaper lamb from New Zealand for the troops in Vietnam. The President told CEA [Council of Economic Advisers] and me to move on household appliances, paper cartons, newsprint, men's underwear, women's hosiery, glass containers, cel lulose, [and] air conditioners. . . . When egg prices rose in the spring of 1966 and Agriculture Secretary Orville Freeman told him that not much could be done, Johnson had the Surgeon General issue alerts as to the hazards of cholesterol in eggs.18

All this was for naught. The slight effects on individual prices and wages were overwhelmed by the emerging economic boom, which put upward pressure on all wages and prices. By early 1966, unemployment was very low (3.7 percent in February), and businesses were planning a huge 19 percent increase in spending on plants and equipment. In this climate, "jawboning" could not do much. In 1966, average hourly earnings rose 4.5 percent, a big jump over the 3.2 percent average from 1960 to 1965. Johnson might have embraced policies—a tighter budget, higher interest rates—to muffle the boom directly. But he wanted neither higher taxes nor higher interest rates. "Jawboning" seemed an alternative. It ended in August 1966, when a major union, the International Association of Machinists and Aerospace Workers, defied the president and negotiated wage gains of nearly 5 percent. The union s president boasted that the settlement "destroy[s] all existing wage and price guidelines." So it did.*19

* LBJ secretly considered imposing mandatory wage-price controls, despite the absence of explicit legislative authority to do so. He planned to use general authority to declare a national emergency under the 1917 Trading with the Enemy Act. He abandoned the idea, dissuaded by the "vehement opposition expressed by those who had helped administer economic controls during World War II and the Korean War," according to Califano.

Despite this experience, economists actually warmed toward "incomes policies"—another euphemism for controls—in the early 1970s, because such policies seemed the only way to reconcile the promise of "full employment" with acceptable levels of inflation. The rationale shifted subtly. With "guideposts," the emphasis had been on the market power of a few highly visible industries. Now, the aim of "incomes policies"—whether voluntary or mandatory— was to permit the orderly suppression of inflation. Everyone would come down together: workers in wages, businesses in prices. No one would gain an advantage. A common analogy involved spectators at a football game. If a few stood up to get a better view, then almost everyone else would ultimately have to stand up (that was rising inflation). But if everyone sat down simultaneously, then all could enjoy a good view (that was falling inflation). On paper, "incomes policies" seemed imaginative, pragmatic and public-spirited. They would prescribe a gradual decline of price and wage increases. In practice, incomes policies and controls were unworkable. Worse, they falsely suggested that there was an administrative solution to inflation.

Although Keynesian economists championed these proposals, they were not alone. Symbolic of the shift was the conversion of Arthur Burns, by then chairman of the Fed. Once critical of the guideposts, Burns said in a speech in May 1970 that the economic rules had changed and that some "incomes policy" might be necessary. Wages and prices rose in good times but didn't decline much in bad. Despite the then prevailing recession and higher unemployment, he noted, wage increases had barely abated. "Market forces" had lost power. Society's success in ensuring prosperity (given that another depression was not a "serious threat") had fostered "cost-push" inflation. Because the unemployed soon expected to be rehired, their wage demands didn't decline. Companies stuck with surplus inventories were "less likely to cut prices to clear the shelves—as they once did. Experience has taught them that, in all probability, demand will turn up again." Government intervention was needed to break the spiral.20

Burns's conversion reflected a growing yearning for a legalistic remedy to inflation—a hope that it could, with bold leadership, simply be swept away. The shift in mood culminated in Nixon's mandatory controls the next year. The trade-off between high inflation and joblessness seemed to have worsened. Unemployment around 6 percent seemed too high, and yet inflation remained stubborn. In July, a series of labor negotiations resulted in inflationary settlements. Steelworkers won first-year increases of 15 percent, prompting an 8 percent price increase. High inflation had weakened US. exports, and a deteriorating trade balance threatened huge gold withdrawals by foreign governments.* Treasury Secretary Connally—like Nixon, an acute political animal—changed his mind about wageprice controls. On August 15, 1971, Nixon simultaneously repudi

* In the summer of 1971, Britain and France converted $800 million into gold, reducing U.S. gold stocks below the symbolically important level of $10 billion. In August, the British indicated they wanted additional assurances that their $3 billion of dollar reserves could be converted at existing exchange rates. Once that became public, the expectation was that demand for gold would overwhelm the limited U.S. supply. In his speech, Nixon closed the gold window.

ated the U.S. pledge to pay gold to foreign governments at $35 an ounce and announced his ninety-day wage-price freeze.21

The history of Nixon's controls can be quickly summarized: They worked; they weakened; they collapsed. After the freeze came Phase II, a testimonial to controls' complexity. It had a Price Commission, a Pay Board (to consider wage agreements) and committees for health services, state and local governments and interest and dividends. To focus on the biggest actors, exceptions to the rules soon multiplied. In early 1972, retail firms with less than $100,000 in annual sales were exempted. In January 1973—the election safely past—Nixon started dismantling controls in Phase III. Prices, artificially suppressed, rose rapidly. Overruling most advisers, Nixon imposed a second freeze. It was a disaster. With grain prices set in uncontrolled world markets, food processors were squeezed between rising feed costs and fixed selling prices. There were meat scarcities; cattlemen withheld animals from slaughter. One chicken hatchery drowned 43,000 baby chicks in barrels; that was shown on national television. "It's cheaper to drown 'em than ... to raise 'em," the manager said. People were shocked. Nixon lifted the freeze on August 12. The remaining controls lapsed in April 1974, when congressional authority expired. In 1974, inflation was 12.3 percent. The harsh 1973-75 recession reflected inflation's erosion of purchasing power.22

Carter's efforts to grapple with inflation were as fumbling and futile as Nixon's—perhaps more so. After a series of unsuccessful antiinflation advisers and programs, Carter embraced an incomes policy in October 1978. It consisted of "voluntary" wage and price stan-

dards, whose complexity made Nixon's controls look simple. In the first year, pay increases were not supposed to increase by more than 7 percent; but in the second, the limit was actually raised to a band from 7.5 percent to 9.5 percent. However, many workers (low-income employees and workers covered by existing contracts) were excluded; by one estimate, that was two-fifths of the labor force. Price standards were equally complicated. To strengthen compliance, the administration investigated the pricing behavior of twelve industries, including meatpacking, cement and shoes. A subsequent study by the General Accounting Office concluded that the program had had "no discernible effect on inflation."23

Indeed, all the programs of wage and price restraints actually made matters worse by obscuring the essential nature of inflation. The deplored behavior of wage and price increases of firms, unions and workers were not themselves the causes of inflation. They were not spontaneous and independent events—as they were often portrayed—reflecting economic power, selfishness or self-interest. They were, rather, the consequences of lax money and credit policies, centered at the Federal Reserve. Companies and workers were merely defending themselves against and, in some cases, exploiting an inflation that was not of their own making. By the late 1970s, this truth was becoming increasingly apparent. But the prominence given to the various wage and price controls reinforced the political climate in which the Federal Reserve would simply follow the signals provided by the White House and Congress.

Everyone wanted an easy escape from inflation. When Carter announced his wage-price standards in October 1978, he pointedly rejected deploying the traditional economic response to runaway inflation. A recession "would not work," he said. Tom Wicker, a well-known columnist for The New York Times, had written in 1977 that the government should relax its "reliance on indirect fiscal and monetary policies" in controlling inflation. Fed governors and their staff had to be affected by this climate. After all, they read the papers, went to receptions and testified before Congress. Not surprisingly, G. William Miller—a businessman who replaced Burns as Fed chairman in 1978—warned of the "limitations of monetary policy as the main bulwark against inflation." As long as that attitude prevailed, there was little chance that anything significant would be done to reduce inflation.24

hrough its history, the Fed has made many small errors but only two major blunders. The first was permitting the Great Depression; the second was fostering the Great Inflation. It is instructive to compare the two because, although the details differed dramatically, the origins of the failures were remarkably similar. Both ultimately stemmed from mistaken ideas that informed the intellectual and political climate and, thereby, the Fed's policies. The failure was not so much of inept individuals as of the faulty doc-

In the 1930s, credit and purchasing power shriveled. From 1929 to 1933, 10,797 banks (42 percent of the nation's total) failed. The fear—and reality—of bank runs caused banks to curb new loans, which worsened the economy and dampened depositors' confi

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