U.S. Inflation Success Came With Costly Price
Good Intentions Combined With Bad Economics Worsened Some Problems
In the view of Robert Samuelson, columnist for Newsweek and the Washington Post, the rise and demise of inflation is the major economic event of the last 50 years. But the dual decline in inflation and in interest rates led consumers to react to their perceived increase in wealth by spending more, he said during a briefing on the economy April 21 at the National Press Club in Washington.
The result was to reduce the U.S. savings rate from 10% of disposable income in the 1980s to zero in 2006. At the same time, the economy appeared more stable, generating only two recessions.
“All these good things went to excess,” Samuelson said. The perception that risk had diminished led to risky decisions, with subprime mortgages being a prime example, he noted. Enormous consumption helped to stimulate other economies around the world and spur the creation of globalization. “The stabilization of the dollar allowed it to resume the role that it played in the ‘50s and ‘60s as a global currency.”
Avoiding Faulty Comparisons to Great Depression
However, Samuelson cautioned against making many analogies between the current recession and the Great Depression. When the economy declined in the 1930s, it seemed to be recovering but then worsened in large part because the government did not intervene to save the financial system, he emphasized.
Between 1929 and 1933, approximately two-fifths of American banks failed, Samuelson said. The banks were the core of the financial system then. He believes that the gold standard was an important mechanism by which this financial instability was transmitted around the world.
“People believed that having their paper currency backed by gold was the only reliable system, and they wanted to cash in their paper money invested in banks or in the stock market,” he said. Consequently, countries, to protect their gold stocks, raised interest rates and basically reinforced the downward effect through adopting a draconian monetary policy.
Policy Activism and Spending to Ensure Credit
Today the central banks of the world are taking a very active policy response to ensure no worldwide implosion of credit as occurred in the 1930s, Samuelson stressed. Therefore governments are more willing to use Keynesian economics in the form of active policy responses and to try to spend their way out of this recession.
Politicians after World War II still had fresh memories of the Depression and were sensitive to the costs of unemployment. Maintaining full employment was their good intention, Samuelson said. But the flawed notion was that monetary and fiscal policy could be adjusted regularly to maintain this result.
This took the form of believing that some compromise was possible between inflation and unemployment. At the same time, accepting a slightly higher rate of inflation could enable a lower jobless rate. The views prevailing in the 1960s and 1970s were a formula for policy erring always on the side of expansion, Samuelson said, which drove inflation higher.
Decline of Inflation After Early 1980s Recession
In 1960, essentially no inflation existed in the United States, he stated. The rate was roughly 1%. By the end of the 1960s, it had increased to about 6%. By the mid 1970s, it was 12%, and by the end of the 1970s and early 1980s the annual inflation rate was about 13%.
Once U.S. inflation had risen above 10%, it took Paul Volcker at the Federal Reserve, backed by Ronald Reagan as president, and an unexpectedly severe recession in 1981-82, to bring the level down, Samuelson added. In Samuelson’s opinion, a subject he also wrote about in his 2008 book, “The Great Inflation and Its Aftermath,” its decline exceeded in importance the Internet and globalization in understanding what happened during this period to the American and world economies.
Financial Times columnist Clive Crook, writing in his December 19, 2008 blog, said that “low inflation fueled reckless optimism which spilled over into speculative excess.” But Crook found that “the idea cuts awkwardly across the theme that Samuelson presumably first had in mind, and which is stamped through [his] book- that a kind of social contract was struck after 1982, in which people accepted less fine-tuning of the economy in return for low inflation and steady growth.”
As interest rates came down and people began shifting their money into the stock market, Samuelson said, most of the increase in stock prices was as a consequence of the decline in nominal interest rates, including in 30-year fixed mortgages. People increased their spending and felt reassured both by their stock portfolios and in seeing the growing amount of stock ownership.
Robert Samuelson at Press Club economic briefing
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