Inflation has altered U.S. economy for past 40 years

Inflation
has altered U.S. economy for past 40 years

BY MARGOT DIMOND

Rice News staff

Saying he is
not an economist, but a journalist who tries to bring “some
kind of commonsensical perspective” to economic issues,
Newsweek columnist Robert J. Samuelson began a 30-minute
primer on the rise and fall of inflation over the last four
decades and its profound effect on politics, the economy
and our national psychology.

Photo by Jeff Fitlow

As Americans enter a new era with new economic problems, they had better understand inflation, noted Newsweek columnist Robert Samuelson in his Feb. 17 lecture, “The Secret History of Inflation.”

His Feb. 17 talk,
“The Secret History of Inflation,” was sponsored
by the President’s Office, the James A. Baker III Institute
for Public Policy and the Jesse H. Jones Graduate School
of Management.

In his introduction,
Rice President Malcolm Gillis said the award-winning journalist
and author “has contributed notably to cultural and
political life in the United States for over 30 years. He
has tackled major issues, from taxation through campaign
finance to civility in public discourse, wading through
mounds of information to produce concise, enlightening commentary
often on topics avoided by less adventuresome writers.”

Samuelson’s
task this day was no less challenging — a review of
the wide-ranging impact of the rare period of “peace-time
inflation” that began in the 1960s and lasted two decades,
when inflation rose from 1.7 percent in 1960 to 13.3 percent
in 1979. Before that time, he said, inflation was a war-time
phenomenon, rising as governments printed money to pay for
war, then subsiding after the war was over.

Samuelson pinned
the cause of this inflation on a popularized version of
the ideas of famed British economist John Maynard Keynes.
“The central notion was that if government was a little
bit more aggressive about using easy credit and budget deficits,
it could keep the economy at something close to full employment,
which was defined as about 4 percent unemployment, and the
only inconvenience would be slightly more inflation,”
he explained.

This policy,
which began with the Kennedy administration and lasted through
the Carter administration, “turned out to be more than
a mistake; it was a disaster,” Samuelson said. “What
Vietnam was to foreign policy, Keynesianism was to economic
policy.”

Inflation got
worse, he said, and so did unemployment, which went from
an average of 4.8 percent in the period between 1950 to
1962 to 6.7 percent from 1970 to 1982.

How did this
happen? According to Samuelson, companies and workers began
to believe that the government could prevent recessions.
This resulted in a wage and price spiral and the accompanying
inflationary psychology as companies turned higher costs
into higher prices, and workers in turn wanted higher wages
to compensate for higher prices. The Federal Reserve, which
regulates interest rates and the nation’s money markets,
would periodically create a temporary fix by tightening
credit and raising interest rates, but the next expansion
part of the business cycle would push inflation higher again.

The lack of stable
money “created an enormous amount of anxiety, stress
and uncertainty because people didn’t know how much
anything would cost in few weeks, never mind a couple of
years,” he said.

Samuelson reviewed
what he sees as the consequences of inflation:

• The
Election of Ronald Reagan

“Reagan’s
election was the direct outcome of two issues: inflation,
which seemed to most Americans out of control, and the Iranian
Hostage Crisis,” he said. “People blamed [President
Jimmy] Carter for both of these.”

During Reagan’s
term, Paul Volcker, who had become the Federal Reserve chairman
late in the Carter administration, raised short-term interest
rates and pushed the economy into the worst recession since
World War II. The unemployment rate rose to 10.8 percent,
but inflation began to recede.

• The
Decline of the Stock Market

“Inflation
killed the stock market,” he said. As people no longer
trusted money, they invested in other things — collectibles
of all kinds, gold and real estate. But they did not invest
in stocks. In 1965, the Dow Jones Industrial Average was
910. In 1982, almost two decades later, it was 884. After
correcting for inflation, stocks were worth less in the
early 1980s than they had been in the 1960s.

• Farm
Foreclosures

In the 1970s,
with crop prices rising, farmers borrowed money to buy new
equipment, build new barns and silos and purchase more acreage.
However, with the rise of interest rates, both crop prices
and demand suffered. Many farmers couldn’t repay their
loans, and there were widespread bankruptcies and foreclosures.

• The
Savings and Loan Crisis of the Late 1980s

In their heyday,
S&Ls made a comfortable profit taking short-term deposits
at low interest rates and loaning money to homeowners for
30-year mortgages at modestly higher rates. Inflation caused
the short-term interest rates to go up, causing the S&Ls
to spend more than they received in payments.

• Slower
Productivity

During this period,
worker productivity went from 3 percent annually to 1.5
percent. Samuelson theorized that business managers felt
they could raise profits by raising prices and didn’t
have to focus on the messy details of running their businesses
more efficiently.

This slow productivity
growth also had a profound effect on the American psyche.
“Progress is America’s national religion,”
he said. “More often than not, we measure progress
in economic terms. Tomorrow ought to be better than today.
Future living standards should always rise. When this didn’t
happen … people felt that they were losing their national
birthright.”

Conversely, Samuelson
credits our current state of “disinflation” —
the slowing of price increases — to the stock market
boom, with the Dow Jones Industrial Average moving from
884 in 1982 to 7,441 in 1997, the increase in productivity
to 3 percent
and the low interest rates stimulating the housing market.
“The gradual disinflation contributed to a stronger
economy, bolstered people’s confidence in the future
and, at the very least, stopped the erosion of trust in
their leaders and institutions,” he said.

Samuelson decried
the lack of discussion about inflation by economists and
historians, but praised “Nixon’s Economy,”
a 1998 book by Rice’s Allen Matusow, the W.G. Twyman
Professor of History and associate director of the Baker
Institute, as a noteworthy exception.

It’s important
to care about this now, he said, because as Americans enter
a new era with new economic problems, they had better understand
inflation — and because the truth is important. “We
ought to try to get history right,” he said.