October 27, 2005
Unexpected Lessons From Greenspan's Fed
When the history of the Federal Reserve is written, one of its most
important chapters will cover the period from 1979 to 2006, when
the Fed was under the stewardship of Paul Volcker and then Alan
Greenspan. That chapter will have a simple title: The Conquest of
who have grown up in an era of price stability, this may sound
like an achievement on the order of kicking sand in the face of
a 98-pound weakling. Those who recall the overheated environment
of the 1970s know it was more akin to pinning Godzilla. In 1980,
inflation hit the blood-curdling level of 14.8 percent. Last year,
it rose by 3.3 percent.
If a time
traveler had come back from the 21st century to 1980 and announced
that inflation would be cut to such low levels, Americans would
have said: "Sure, we believe you came back from the future,
but that stuff about curbing inflation -- how gullible do you
think we are?" Even when inflation is rising, as it is now,
no one expects it will come remotely close to the heights it once
and Greenspan did about chronically soaring prices, however, may
be the least of their accomplishments. Their bigger one was slaying
some of the most destructive myths about the economy, thus helping
to restore government to a smaller, better role in the nation's
arrived, inflation was seen as the fault of undisciplined private
markets. The idea was simple: Left to their own devices, workers
demanded higher wages, and companies responded by raising prices,
causing workers to demand still more, leading to even higher prices
-- in an endless upward spiral that forced consumers to pay more
and more all the time. Only the restraining hand of a benevolent
government could break this cycle, as it tried to do under President
Nixon's wage and price controls.
out to be about as successful as the Hindenburg, but the failure
didn't stop President Gerald Ford from urging Americans to join
in a campaign to "Whip Inflation Now" by doing things
like carpooling -- while vowing that the federal government would
closely scrutinize all wage and price increases.
it dissuade President Carter from maintaining price controls on
oil and natural gas, which succeeded brilliantly, assuming the
goal was to create shortages and chaos.
It was Ronald
Reagan, in his first inaugural address, who said, "In this
present crisis, government is not the solution to our problem;
government is the problem." But by then the Fed, under Volcker,
had already recognized the crucial truth about inflation: It wasn't
created by a greedy, short-sighted private sector, but inflicted
on the private sector by the government's easy-money policies.
Laureate economist Milton Friedman had claimed for years was finally
sinking in: "Inflation is always and everywhere a monetary
phenomenon." And monetary phenomena, unlike union contracts,
retail pricing decisions and world oil markets, are directly under
the control of the Federal Reserve.
set about using that control -- curtailing the growth of the money
supply, pushing up interest rates and administering a terrible
shock to an economy that had built in firm expectations of endless
price increases. By 1981, double-digit inflation was gone, and
by 1982, it was below 4 percent.
howled, lamenting that this monetary tightening was cruelly replacing
one problem with a worse one: mass layoffs. During the 1981-82
recession, the jobless rate climbed to nearly 11 percent. Some
achievement, they said.
the conventional wisdom was that we had to choose our poison.
If we wanted a prosperous economy and low unemployment, we had
to accept inflation. If we wanted low inflation, we would have
to put up with a sluggish economy and sentence millions of people
to a life on the dole.
and Greenspan, however, proved that a free-market economy can
furnish plenty of jobs if the government avoids monetary profligacy.
In the 1990s, the Fed kept inflation consistently well below what
it had been in the previous two decades, but unemployment dropped
to levels once considered unreachable. Inflation, it turned out,
was not the solution; inflation was the problem.
discovery of the last quarter-century is not that the government
should do nothing, but that it should focus on doing certain essential
tasks -- one of which is to avoid debasing the currency on which
all economic activity depends. Long after Greenspan and Volcker
are forgotten, Americans will still be in debt to them for that
2005 Creators Syndicate