The Full Employment Obsession

You may wonder: How did this happen? If the United States had never before experienced a prolonged peacetime inflation, why did one start in the 1960s? The short answer is the power of ideas. In the 1960s, academic economists argued—and political leaders accepted—that the economy could be kept permanently near "full employment" (initially defined as 4 percent .unemployment). Booms and busts, recessions, and depressions had long been considered ugly and unavoidable aspects of industrial capitalism. But once people accepted the idea that the business cycle could be mastered, then the self-restraint that had silently kept prices and wages in check gradually crumbled. New assumptions emerged. If government could prevent recessions, then companies could always count on strong demand for their products. All higher costs (including higher labor costs) could be recovered through higher prices. Similarly, if the economy was always near "full employment," then workers could press for higher wages without facing job loss. If their current employers wouldn't pay, someone else would. Government wouldn't tolerate substantial unemployment; that was its promise. The result was a stubborn wage-price spiral. Wages chased prices, which chased wages. Inflation became self-fulfilling and entrenched. It was that simple.

We know now that the promise to eliminate the business cycle was fated to fail. If it inspired inflationary behavior (as it did), and if rising inflation threatened economic expansion (as it did), then there was an inescapable collision. All this is obvious now, but it wasn't then, at least to most people. For one thing, inflationary behavior emerged slowly. There was not a collective flash, when business executives, union leaders and ordinary workers concluded, "Gosh, government has abolished recessions. No one need worry that huge wage and price increases will ruin our businesses or destroy our jobs." Instead, Americans quietly observed that price and wage gains that, in the past, would have been dangerous were no longer so. Inconvenient bursts of inflation were blamed on onetime events: spending for the Vietnam War or global surges in oil prices. If these temporary causes explained most inflation, then the basic promise—the mastery of the business cycle—remained operative. Unfortunately, most inflation did not stem from temporary causes.

It is hard for us now to recall the single-mindedness with which both Democrats and Republicans pursued "full employment" in the late 1960s and 1970s. Not surprisingly, Richard Nixon, a man of acute political sensitivities, best captured the obsession. "When you start talking about inflation in the abstract, it is hard for people to understand," he commented early in his presidency. "But when unemployment goes up one half of one percent, that's dynamite____The public has had eight years without a recession [in the 1960s]... .We can't allow—Wham!—a recession. We'll never get in [office] again." Low unemployment was the be-all and end-all of economic policy; inflation was an inconvenient nuisance. Those priorities endured for more than a decade. Looking back on the Carter presidency (1977-81), Stuart E. Eizenstat, the White House's chief domestic adviser, later confessed:

The principal fault of the economic policy of the Carter years was a failure to identify the ferocity of the underlying inflationary pressures of the economy. We stuck too long to the stimulative fiscal and monetary policies promised in the 1976 presidential campaign, to end what we called "the Ford recession." In retrospect, we were blind until it was too late to the rising level of inflation____The president's top aides, myself included, and the Democratic party in general, feared and tended to oppose any economic decision which risked restraining growth and causing higher unemployment to fight inflation.1

Political ideas often follow the familiar cycle of infatuation and disenchantment. In all infatuations, everything initially seems perfect. Life has a special glow. The future seems full of promise and pleasure. Sooner or later, strains intrude. The romance loses luster.

Sometimes it evolves into a sturdier relationship; sometimes it sinks into recriminations and remorse. So it was with the pledge to abolish business cycles. At first, the performance matched the promise. Slowly, complications arose; there were desperate attempts to retrieve the original promise—mainly through various wage and price controls. People abandon cherished beliefs slowly, usually only when confronted with massive evidence of error. By the late 1970s, such evidence was at hand, and inflation's destructive effects spread disillusion. People no longer believed the original promise.

ur story starts with John F. Kennedys election in 1960. En tering the White House, Kennedy did not have an explicit economic agenda. He certainly did not argue that business cycles could be eliminated—an idea that would have struck most Americans as absurd. But he had campaigned on the vague pledge to "get America moving again." Exactly what that meant in practice was unclear because America had been prosperous in the 1950s, with the exception of a significant recession in 1957-58 (unemployment averaged 6.8 percent in 1958, up from 4.1 percent in 1956). But Kennedy's argument was not just for more prosperity and less poverty. He connected America's economic performance at home with its ability to confront the Soviet Union abroad. "We must recognize the close relationship between the vitality of our own domestic economy and our position around the world," he said in one

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