Central bankers, despite their avowed antipathy to inflation and the powerful weapons they could wield against it, have failed utterly in this mission in recent years.
Published in the New York Sun.
“Our economy is faced with a threat of gradual or creeping inflation over the coming years,” wrote the distinguished economist Arthur Burns in 1957. “It is highly important that we try to stop the upward drift of the price level.” Burns pointed out that over time “even a price trend that rises no more than 1 percent a year will cut the purchasing power of the dollar,” adding that 2 percent would cut it much more. He was right about that.
Consistent with this view, Alan Greenspan, when chairman of the Federal Reserve, suggested that the right inflation target was “zero, correctly measured,” and the Humphrey-Hawkins Act of 1978 stated that zero inflation was a long-term goal.
How fashions in monetary ideas do change. While Burns in the 1950s attacked 1 percent or 2 percent inflation, and Greenspan and an act of Congress suggested zero inflation, we never hear about the danger of “creeping inflation” anymore.
Instead, since the Fed chairmanship of Ben Bernanke, our monetary mandarins earnestly promise us that they will do what Burns feared, that they will create 2 percent inflation forever — in other words, they promise to unendingly depreciate the purchasing power of the dollar so it goes down by 80 percent in a lifetime of 80 years. That is the mathematical result of 2 percent a year.
Of course, gradual inflation can turn into runaway inflation, as it did during the 1970s and again between 2021 and 2023. Under the “2 percent inflation forever” theory imposed by the Fed under Bernanke and maintained by its successors, the people’s purchasing power, which is lost to a period of runaway inflation, plus all past creeping inflation, is lost to them forever. Overall consumer prices under this regime must always keep getting higher, just as they are doing now, eroding real wages and robbing savers.
With vast irony, in the Great Inflation of the 1970s, Burns himself was chairman of the Federal Reserve. In September 1979, Burns, after he had left the Fed, gave a remarkable speech entitled, “The Anguish of Central Banking.” In what one might picture as a tragic dramatic soliloquy, Burns uttered this cri de coeur:
“And yet, despite their antipathy to inflation and the powerful weapons they could wield against it, central bankers have failed so utterly in this mission in recent years. In this paradox lies the anguish of central banking.” He continued, “I have reluctantly come to the conclusion that fairly drastic therapy will be needed” along with “painful economic adjustments that I fear are unavoidable.”
In the drama of the time, Burns fades out. Enter Paul Volcker. The new Fed chairman is ready and willing to undertake drastic therapy and becomes the anti-inflationist hero and legend. Volcker proceeds with firm steps and a cigar to center stage.
There he made it clear that he considered the costs of continuing high inflation were greater than the costs of reducing inflation. In particular, he rejected the Keynesian Phillips Curve approach of trying to buy employment with inflation that had led to stagflation.
Volcker’s program involved letting interest rates rise to levels unparalleled before or since, crushing among other things the savings and loan industry, and triggering a very deep and painful recession. It was a dark and serious downer, highly controversial and subject to great uncertainty.
Volcker, though, was firm about what he judged the overriding long-term interest of the country: breaking the runaway inflation. Which he did. Inflation was running at 13 percent a year when he entered office, and at 4 percent when he left in August 1987.
However, if in 1987 inflation was not runaway, it was still endemic and significant. At 4 percent inflation, the purchasing power of the dollar will fall by 96 percent in a lifetime.
In 1990, Volcker was the speaker for the same international lecture which had featured Burns’s anguish eleven years before. The title this time was “The Triumph of Central Banking?” Volcker remarked that “my impression that central banks are in remarkably good repute these days,” but he pointed out the question mark in his title. “I think we are forced to conclude that even the partial victory over inflation is not secure.”
Volcker was right, as our experience since then demonstrates. From the end of 2020, the Consumer Price Index has gone up 29 percent. It is now twice what it was in 2000 and three times what it was when Volcker left the Fed in 1987. It is 12 times what it was when Burns was writing in 1957.
If Burns and Volcker are watching from central banking Valhalla when Chairman Kevin Warsh one day addresses inflation in his own farewell soliloquy, will they hear about “anguish,” “triumph,” failure, or partial victory — or perhaps of a golden success of sound money with stable prices? Let us hope for the last of these.