1970s Inflation: The Economic Fever That Changed America

Summary

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The Marginal Revolution Podcast

Episode: 1970s Inflation: The Economic Fever That Changed America

Hosts: Alex Tabarrok [A] & Tyler Cowen [B]
Date: September 20, 2024

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Episode Overview

In this lively episode, Alex Tabarrok and Tyler Cowen turn their economic expertise and trademark wit to the tumultuous economic landscape of the 1970s—an era infamous for soaring inflation, fiscal experimentation, and pivotal shifts in monetary norms. Together, they dissect the origins of 1970s inflation, debate the role of Keynesian economics, revisit the demise of the gold standard, explore political influences on central banking, and compare lessons from the past with current inflation experiences. The dialogue is packed with historical context, critical analysis, and a few light-hearted jabs.

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Key Discussion Points & Insights

1. Setting the Stage: The 1970s as an Economic Turning Point

• Inflation’s Scale: By 1974, U.S. inflation hit 12.5%, peaking around 15% by decade’s end.

  “The 1970s is an especially interesting decade to me because it seems to be the time when we Americans just did everything wrong.” – Tyler [00:42]

• Broader Turmoil: Economic woes coincided with political crises (e.g., presidential resignation, productivity slump).

2. Milton Friedman, the Public, and Wrong Predictions

• Friedman’s Pessimism: Milton Friedman, in a 1979 paper, predicted inflation would only be curbed at 25%, which proved false.

  “A lot of this podcast today will be about incorrect predictions. But what was it Milton got wrong?” – Tyler [01:15]

• Public Intolerance: Alex contends the general public hated inflation far more than economists anticipated, providing crucial resistance.

  “The thing pushing back was really the public.” – Alex [01:35]

3. Causes of 1970s Inflation: Fiscal Expansion and Policy Innovations

• The “Keynesian Revolution”: Alex attributes inflation to politicians’ embrace of Keynesian fiscal policy, especially the Kennedy and Johnson tax cuts, abolishing the myth that deficits are inherently inflationary or immoral.

  “Then along comes Kennedy...He brings the new economics to the White House...one of the big goals of the new economics was to get rid of the taboo on deficit spending.” – Alex [03:01]

• Loss of Fiscal Discipline: Instead of true countercyclical policy, politicians simply favored perpetual spending and tax cuts.
• Political Cycles: Politicians’ incentives clashed with sound economic theory; raising taxes or cutting spending proved politically impossible.

4. The Collapse of Bretton Woods & the Move to Fiat Currency

• Systemic Shift: The demise of Bretton Woods and the gold-backed dollar allowed for more flexibility—but also more inflation—rooted in political decisions, not accidents.

  “You got rid of the prudence and frugality, and then you got rid of the gold standard...that was like the second fence, which was eliminated.” – Alex [07:53]

• Global Liquidity: The world’s need for dollar supply (T-bills as reserve assets) drove U.S. deficits, with some arguing this was inevitable for global finance.

5. Political Pressure on the Federal Reserve

• Nixon & Arthur Burns: Nixon’s political management of Fed Chair Burns exemplified how central bank independence could be manipulated or overridden.

  “Nixon jokes...‘I respect his independence. However, I hope that independently he will conclude that my views are the ones that should be followed.’” – Alex [13:01]

• Central Bank Independence as Myth & Ideal: There’s debate about whether the U.S. ever had a truly independent central bank before the late 20th century, and whether such independence is ever more than a fragile norm.

6. The Safe Asset Debate

• T-Bills & Alternatives: Tyler and Alex debate whether government-issued T-bills are unique as safe assets or if private finance could suffice.

  “I have no doubt that our incredibly innovative and evolutionary financial system will create safe assets in abundance, if that is what the market demands.” – Alex [16:38]

7. Inflation’s Immediate Causes: Monetary and Fiscal Side

• Sumner’s Take: Tyler invokes Scott Sumner; the Fed let nominal GDP and the money supply grow too fast, abetted by fiscal policy changes (e.g., abandoning gold backing).

  “If you look at demand for money in the early to mid-60s, it's not that stable. It's not actually fitting the Friedmanite model.” – Tyler [22:50]

• Disagreement over Inevitability: While Tyler sees the gold standard collapse as an inevitable root cause, Alex frames it as a political (and ultimately, negative) choice.

8. Supply Shocks: Energy Crises

• Both agree that the 1973 and 1979 oil crises contributed, but that inflation started before these events and supply shocks alone can't explain persistence.

  “Inflation began before the supply shocks. So the energy crisis contributed in the short run.” – Alex [20:38]

9. Economist Blunders: Wage-Push & Cost-Push Fallacies

• Wage Push Theory: Tyler criticizes 1970s Keynesians (Samuelson, Tobin, et al.) for blaming wage demands and cost-push dynamics, rather than monetary factors.

  “The whole idea of the cost push inflation seems crazy to me...Which one is cost? When, which one is pushed?” – Alex [22:15]

• Expectations Muddle: The Keynesians likely overcomplicated expectations, overlooking more systemic price interconnections.

10. Modern Comparisons: Recent Inflations & Different Outcomes

• Reduction Without Pain: They note that post-pandemic inflation (2021–2022) fell from 8.9% to about 3%—with little unemployment spike—unlike the brutal early 1980s Volcker recession.

  “We managed to do that without an increase in unemployment.” – Alex [26:27]

• Possible Explanations: Anchored inflation expectations and unique pandemic-related factors are offered as reasons for the less painful adjustment.

11. Inflation, Expectations, and the Vibes

• “Vibes” Matter: The 1970s felt more perilous and chaotic, with fears of American decline affecting expectations and public sentiment.

  “In our sophisticated discussion, we can talk about expectations. In an unsophisticated discussion…we can talk about the vibes.” – Alex [31:19] “The vibes were better this time than in the 1970s.” – Alex [31:31]

• Historical Anxiety: Tyler recalls firsthand how, in the ‘70s, there was widespread genuine fear of permanent U.S. decline.

12. Final Takeaways & “Bottom Lines”

• Alex: The abandonment of balanced budgets and fiscal myths led to persistent deficits and political business cycles, not stabilization.

  “…abandoning balanced budgets doesn't lead to countercyclical fiscal policy...but rather to political business cycles, bigger governments and perpetual deficits.” – Alex [33:07]

• Tyler: Some bad outcomes (inflation, deficits) were inevitable or even necessary (especially after Bretton Woods), but the question is whether better moderation was possible.

  “…a bunch of things that are bad are sometimes inevitable. And the key questions are, can we get some more moderated versions of these things?” – Tyler [34:30]

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Notable Quotes & Memorable Moments

• On the Culture of Deficit Spending:
  “Kennedy, the new Camelot...brings the new economics...He brings people like Waller, Heller, James Tobin, Robert Solow...one of the big goals was to get rid of the taboo on deficit spending.” – Alex [03:01]

• On Central Bank Independence:
  “The real purpose was to barbecue Martin.” (re: LBJ summoning the Fed Chair) – Alan Blinder, quoted by Alex [12:00]

• On Economic Modeling Gone Wrong:
  “The key point, I think, is about geopolitics and also the collapse of Bretton Woods...you're going to have higher inflation rates.” – Tyler [06:15]

• On Modern Inflation:
  “We managed to do that without an increase in unemployment.” – Alex [26:27]

• On the Limits of Understanding Expectations:
  “Expectations are one of the things which economists understand the least.” – Alex [31:17]

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Important Timestamps

• [00:42] – Tyler on the 1970s as a time of economic missteps
• [01:35] – Alex: Public hatred of inflation exceeded economists’ expectations
• [03:01] – Alex: The Kennedy/Johnson Keynesian turn
• [06:15] – Tyler: Geopolitical drivers and Bretton Woods
• [13:01] – Alex: Nixon’s manipulation of the Fed
• [15:47] – Tyler: Safe asset creation and fiscal theory
• [18:04] – Tyler: Sumner’s nominal GDP story
• [20:38] – Alex: Supply shocks and prior inflation
• [22:15] – Tyler: Keynesian missteps, wage-push errors
• [26:27] – Alex: Modern inflation and unemployment decoupling
• [31:29] – Alex: The importance of “vibes” and expectations
• [33:07] – Alex: Final critique of busting fiscal taboos
• [34:30] – Tyler: The inevitability and moderation of bad outcomes

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Summary

This episode offers a sweeping yet detailed exploration of the inflationary fever of the 1970s, blending economic theory, historical anecdotes, and sharp debate. Alex and Tyler revisit the intellectual misjudgments and policy sins of the era (and the economists who made them), while thoughtfully weighing how those lessons apply (or don’t) to today’s inflation challenges. The conversation is accessible, provocative, and colored by both scholarly authority and personal memory—a must-listen for anyone interested in economic history, monetary policy, or the enduring tug-of-war between politics and macroeconomic prudence.

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Transcript

[A]

Welcome to the Marginal Revolution podcast. We're going to be talking about the 1970s. Now, if you think about the 1970s, I think the first thing that comes to mind is disco. But the second thing is inflation. And we don't know much about disco, do we, Tyler?

[B]

Well, speak for yourself.

[A]

Okay, Right. I wasn't there in New York, but maybe you are at the clubs. But we do know maybe a little bit about inflation. So let's see. Inflation absolutely did take off in the 1970s. You know, by 1974, inflation was 12, 12 and a half percent. And by the end of the 1970s, it had hit as high as 15%. And the question is why? Why did inflation take off at this period of time?

[B]

The 1970s is an especially interesting decade to me because it seems to be the time when we Americans just did everything wrong. Right. So productivity growth goes down the toilet, inflation is high. There's a lot of political disorder. A president has to resign. Is there any unity behind these trends? And as you know, we'll be doing a few other podcasts talking about other aspects of the 70s. But one thing that struck me, I was reading a book recently called the American Economy in Transition, edited by Martin Feldstein, published 1980. There's a paper in there by Milton Friedman, which I think must have been from 79. And Milton says he despairs that we're going to attack inflation I until it reaches at least 25%. Right now that was an incorrect prediction. And a lot of this podcast today will be about incorrect predictions. But what was it Milton got wrong in saying that?

[A]

Yeah, I think one of the surprising things is that the public actually hates inflation more than economists do or more than economists expected. And that's the one thing which has kept inflation at bay. So we'll be talking about. I mean, there were lots of reasons for inflation, but. But the thing pushing back was really the public.

[B]

And I think in part, Friedman may have been influenced by the experience of Israel, which had rates of inflation. I don't remember the numbers, but I remember 40% and then higher. And they finally got that under control. And then there were Latin American experiments where inflation had to run very high before it got under control. And just some differences between these countries. Somehow his model didn't have enough cultural richness to see that. Maybe. I suppose that would be my best explanation of what he got wrong. What do you think?

[A]

Possibly let's go back a little bit earlier and talk about when inflation started and what were some of the causes. And then maybe we'll Come back and talk about what Milton Friedman got wrong and why didn't get worse than it actually, because it just seemed to be.

[B]

Getting worse and worse for quite a long period of time.

[A]

Yeah.

[B]

And then maybe he had recency bias, Right?

[A]

Yeah, yeah, yeah, sure. I mean, that makes total sense. And the politics were all pushing towards more inflation. So I'm surprised we didn't get more inflation. And as I said, I think the public just hates it.

[B]

I was surprised at the time when Volcker did everything he did. I said, whoa, I was not expecting this.

[A]

Yeah, we took big costs to reduce inflation.

[B]

That's right.

[A]

Yeah. But now we're getting ahead of ourselves. So let's go back and look at the beginnings of inflation. And I actually would blame inflation on the Keynesians, okay? And I would blame it on the, the Kennedy Johnson tax cuts of 1962 and 1964. Now, not because these tax cuts themselves were inflationary, but rather because these tax cuts were really the first truly Keynesian fiscal policy in U.S. history. Now Keynes had argued, of course, in 1936 in the general theory that, that we should use deficit financing to combat a recession, the Great Depression. But really in the United States at the time, the idea of a balanced budget, that still had held sway among both Republicans and Democrats. So a government might run a deficit, you know, in a recession, but that was sort of accidental, right? Your taxes go down, your spending stays the same, you run a deficit, but then they would run surpluses, right, to pay down the debt. And you had a war, okay? So your spending goes up, but then you pay down, you have surpluses, okay? Surpluses were the norm, right? Frugality and prudence were sort of the words of the day. Then along comes Kennedy, right? And Kennedy, the new Camelot, the new guy, okay, the young guy, he brings the new economics, right? He brings the new economics to the White House. He brings people like Waller, Heller, James Tobin, Robert Solow, future Nobel Prize winners, okay? And Tobin, future Nobel Prize winner. He argues that one of the big goals of the new economics was to get rid of the taboo on deficit spending. And Walter Heller, okay, he was in charge of all this. He says John F. Kennedy and Lyndon Johnson stand out as the first modern economists of the American presidency. Their administrations were largely free of the old mythology and wrong headed economics which had viewed government deficits as synonymous with inflation. Government spending increases as a likely source of depressions and government debts as an immoral burden on our grandchildren. All of that is gone. All of that is gone. Okay, so what happens? Well, there's two problems in theory, right? Keynesian's policy is supposed to be countercyclical. Increase spending and cut taxes during a recession and cut spending and raise taxes during a boom. But of course, politicians, they only like half of this rule. What politician wants to raise taxes and cut spending? So my view of what generated the inflation of the 1970s is that the politicians took from the Keynesian economists this idea that spending increases and tax cuts could stimulate an economy. And they just ran with it and they didn't stop.

[B]

But wait, I like these tax cuts, so let me try to defend them. All right, first, they had some positive supply side effects over exaggerated by the supply siders themselves. But there's always something to be said for better incentives. Right? That's the first lesson of economics. But the key point I think is about geopolitics and also the collapse of Bretton Woods. So if you're moving from a world where the dollar is partly backed by gold in a complicated way to a world of fiat currency, you're going to have higher inflation rates. Right. If you think of John Cochran physical theory of the price level, you don't have to buy the whole theory to see a dollar that is less backed by commodities is going to be worth less in the equilibrium one way or the other.

[A]

Sure.

[B]

So you're going to get there. A problem under Bretton woods for such a long time was there's just a dollar shortage in the world. US dollar was, is and should be the global reserve currency. So you need to come up with a way of supplying more liquidity to the world. And T bills are that they're a form of dollars for the world. So the United States should run a deficit to boost the supply of liquidity. I think that's an old Michael Woodford argument, if memory serves. And it's just inevitable. Otherwise the global economy is just choked off by not having enough dollar based assets.

[A]

So I agree with what you say about the collapse of Bretton woods, but I see that as a further Keynesian idea to get rid of the old bugaboos and the old taboos. You know, gold is, what was Keynes term, Barbarous relic. But look, barbarous relic.

[B]

He had to get rid of the gold standard.

[A]

No, no, we did.

[B]

It's not an accident that it collapsed.

[A]

No, no, no, no. It was, it definitely wasn't an accident. No, it was done on purpose. And it was done on purpose so that the politicians could further stimulate the economy. So you think about all of the things which were holding them back. One of them was this idea of prudence and frugality. And then the Keynesians come along and they. It's like Chesterson's fence, right? And they say, what's this fence doing here? We don't need that, okay? They didn't understand what the fence was in the first place. And the pur. The fence was to hold back the political inclinations to spend more and to try and stimulate the economy to win reelection. So you got rid of the, the, the, the prudence and frugality, and then you got rid of the gold standard, which was also holding them back. So that was like the second fence, which was eliminated.

[B]

Look, I, I don't like the Keynesians, but Friedman, for one, was very happy to see the gold standard go. Had we stayed on a gold standard, given subsequent volatility in the price of gold, there would have been phenomenal macroeconomic volatility, and in fact, we would have just cut the tie anyway. It was never going to last. But there was this fundamental contradiction that Europe in particular relied on the US to keep on increasing the supply of dollars because there was a sort of dollar shortage over there and it was their reserve currency. The other economies weren't strong enough, and there was no euro. Yet at the same time, the dollar was to be convertible into gold. So in the short run, we solved quite quote, unquote, that problem by just twisting the arms of them, especially the French, and saying, we're not actually going to let you convert your dollars into gold and we're going to keep on sending you dollars. And at some point the French just said like, no way. And they started converting and the thing collapsed. But there was never a way to keep it going that I can see. Unless you just impose a lot of deflation on the global economy, which would have been worse than what we did.

[A]

No, no. The increase in the volatility of the price of gold, that was endogenous, that was caused by going off the gold standard at first.

[B]

But later on it was China, right?

[A]

Maybe. But moreover, the reason why Bretton woods came under attack was that all these other countries, including France, which were holding dollars, they realized that the US Government is inflating. The US Government is destroying the value of the dollars.

[B]

But they also demanded that we inflate. Right. They need more dollars.

[A]

I don't see it that way. I don't see it that way.

[B]

Let's say the US had been on some kind of 100% reserve fractional banking, just to take an extreme case, not saying that was under consideration at the Time. Really? You agree that would have been too deflationary for the global economy. Right.

[A]

I don't see the inflation as being a response to potential deflation. Right. So we never saw the deflation to which inflation might have been a response. We just saw the inflation.

[B]

But Europe is booming. Japan is on the verge of booming.

[A]

There's a big. That's a huge counterfactual. And I don't see how the naked self interest of the politicians somehow led via a political invisible hand to solving the safe asset problem, which you're sort of talking about.

[B]

I think Keynes set up a booby trapped system. He knew it was booby trapped. In the long run, we're all dead. Another Keynesian remark. And he just figured when we got to it, people would sort it all out. And I think he would have been quite pleased to see that his tracked on monetary reform proposals, fiat currencies with floating rates, where he and Friedman more or less agree in that work, at least that that's where we would end up. Because what else was there? So I think Keynes saw this all. Yes. Along the way we inflated far more than we should have. That was stupid. Nixon intimidating Arthur Burns was stupid. But something like that probably had to happen given that Bretton woods was always booby trapped and never could have just continued as it was. And what's this weird thing, a gold standard, but only foreigners can convert.

[A]

Yeah, I hear you.

[B]

It makes no sense. And it was always geopolitical, like we're not actually going to let you convert. From the beginning, only in very limited doses.

[A]

I mean, it was built upon the premise that the United States wouldn't inflate. And the United States started to inflate, so it fell apart. We can also see what was going on by looking at Arthur Burns. Right. And Nixon.

[B]

And that was terrible.

[A]

Okay, but was it terrible or was it the invisible hand working itself out to solve this problem of deflation and the need for liquid assets? I think it was just terrible. Right. And moreover, the political control of the Fed was a logical necessity for Keynesian policy. Right. As well as being highly desirable to politicians. So Johnson, even before Nixon. Johnson, right. Was furious at the fed chair, William McChesney, and he summoned him to his ranch. And Alan Blinder has a great line on this. He says, though I imagine that Texas beef was served. The real purpose was to barbecue Martin. Okay, and then you have Nixon. And Nixon to his credit, totally understood monetary policy, right?

[B]

Yes.

[A]

Better than perhaps any president, certainly since maybe even before. Right. And he was the king of the Political business cycle. And he appoints his friend Arthur Burns, Right? He appoints him first as a special advisor and then to the chair of the Fed. And at Burns is swearing in. This is incredible, right? Nixon jokes that, quote, I respect his independence. However, I hope that independently he will conclude that my views are the ones that should be followed. Right. And so he puts all this pressure on Burns. And this is all in Burns diaries that Nixon is calling him up up and demanding to loosen monetary policy. In fact, it's in the news. It's not a secret. Right?

[B]

Yeah. I think you're yanking this out of context. The US has never had much of an independent Fed, especially back then. So when Roosevelt cuts the tide of gold, that's not an independent fed. World War II, of course, the Fed wasn't close to independent. 1951 Fed Treasury Accord. The Fed is like literally on paper, not at all independent. See, you have this brief window of time with some partial independence, which was fine, to be clear. And Nixon comes along and does something bad. But it was not really breaking some earlier well established social contract. It was quite in tune with broader paths of American history, which is we've not mostly had an independent central bank and it's a miracle we got a bit of one later, which probably we're back to now.

[A]

Yeah, I mean, that just goes to show that a central bank is one of these institutions which is only maintained as a sort of barbarous relic. Right. Is only maintained because of sort of ethical views that to break this idea would be bad. And that equilibrium is something which has to be fought for. That equilibrium is something which needs to be protected. Maybe by some mythology, but it's an important mythology to protect. Because what we've seen with independent central banks is that inflation is lower and unemployment is no higher. So to have a independent central bank is almost a free lunch because you get lower inflation. But the dependent central bank does not actually reduce business cycles in the way that Keynesian theory suppose that it should.

[B]

You would agree though, it's a good thing that we run budget deficits, though admittedly not at current levels, which I think are close to 6% of GDP in 2024. Well, because you create another safe asset. Right. David Beckworth point. There's no shortage of safe assets. The world needs more of them. There's not anything else you can use? Not at the moment.

[A]

We can create safe assets. Okay, and they're called T bills.

[B]

What else are they?

[A]

Well, we can also create lots of safe assets, you know, using tranching of corporate bonds. And using real estate, using. There's lots of ways to create safe assets. I.

[B]

They're much less safe, they're much, much.

[A]

Less focal, they're not much, and there's.

[B]

Not a one of them that everyone coordinates around.

[A]

The US has been unusual in its ability to create what in the world context is relatively safe assets, but I don't think that's necessary for the world economy.

[B]

So like Fang plus Nvidia, those are our safe assets. They're commercial paper, if you. They're not mainly in debt, those companies. Right, like they issue commercial paper. But in terms of how much there is there, I'm not even sure what the number would be.

[A]

I have no doubt that our incredibly innovative and evolutionary financial system will create safe assets in abundance, if that is what the market demands. I mean, we have an incredibly complex and sophisticated financial system, the most sophisticated financial system the world has ever seen. We have options, we have tranches, we have lots of different ways of combining assets in order to create safe assets. That is what our financial system does. That is what we want a sophisticated financial system to do. Leaves the creation of safe assets to New York, Manhattan, Wall Street. We don't necessarily need them created by the US government, but maybe those safe.

[B]

Liquid assets are a public good. As you know, following the financial crisis, we took this enormous push forward to create a lot more safe assets that bear interest return by paying interest on bank reserves held at the Fed in a way that was like issuing a lot, lot, lot more T bills in a mini way. We don't call them T bills, but it's also another example of how central banking has never so much been independent. And what we saw in the 70s, again, there's plenty I don't want to make excuses for, but I view it as much more inevitable than a lot of commentators want to think.

[A]

So let me ask then, Tyler, what were the causes of the inflation of the 1970s?

[B]

I think there's several causes. First, in Scott Sumner's terminology, the Fed let nominal GDP grow at too higher rate. You could rephrase that in terms of the money supply.

[A]

What do you mean the Fed let. I mean the Fed. The Fed made nominal GDP grow too quickly.

[B]

It's jointly determined by the private sector and the Fed, given political constraints and acting in cahoots, so to speak. And GDP is growing at way too higher rates. Or you could rephrase that in terms of the monetary aggregates, M2 also being jointly determined with the private sector, to be clear. But mostly it's the Fed. But then you have on the fiscal side, the dollar simply not being backed the way it used to be. So of course it's going to end up worth less. And exactly how you get there, you could say, well, fiscal theory of the price level is weak. On that I would agree, but it's what you should expect. So I also think it was a good thing we got off gold when we did. So I'm not upset about that. Even though I clearly would admit the concomitant inflation was bad for the economy.

[A]

Yeah. So I think we agree that going off the gold standard was one of the causes of the inflation.

[B]

You think it was good?

[A]

No, we had to. You think it was fortuitous? I think it was a dastardly deed done by Nixon and the Keynesians.

[B]

Well, the motives may have been bad from Nixon, that's fine. But in terms of the actual effects, and again, say we'd stayed on gold, if that's even imaginable. Like South Africa is a major supplier of gold that turned out to be more stable than many people expected. But everyone at the time was quite worried, like, oh, so much gold from South Africa. What's going to happen there? And then just rise of China, commodity prices go haywire. What, starting about 25 years ago, we couldn't have gotten through that.

[A]

There are many other things which could have happened, but we could have done a Robert hall ancap stand or something like that. Who knows? The world certainly would not have remained in exactly the state that it was. We didn't have to go down the path of inflation. Now we haven't actually talked yet about supply shocks. We're going to do a whole episode on price controls and also on the two energy shocks. But what is your view on how the energy shocks in 73 and 79 added to inflation?

[B]

Oh, of course. And that you just see in the numbers. It's the same as our more recent inflation. Some of that was from COVID related shocks, some from shocks related to the war in Ukraine. And that's not controversial. I think it's just how it happened. And it happened twice.

[A]

Yeah, I agree with that. I would say, and I think it's important to point out that inflation began before the supply shocks. So the energy crisis contributed in the short run. Now in the long run, you have a increase in the price of oil that should only affect relative prices. There's no particular reason that it's going to affect inflation for very long. But in the short run, yeah, some prices are sticky and you get an increase in inflation with an increase in the price of oil. So we had sort of bad luck.

[B]

Absolutely. Very bad timing. Yeah.

[A]

To have these things.

[B]

Bretton woods floating rates, fiat currency, oil shocks in the same decade was really very bad. But I want to do some economist bashing and blame a lot of famous economists, which you were doing a bit earlier. So you go back and you read these people at the time. And I did this quite closely for Paul Samuelson because of my goat project. And they believed the Keynesians in wage push inflation, which is not so much the case today, though it's in a weird way, coming back a bit. And that was just wrong. And when you look at how decisions were made, monetary policy decisions were made on the basis of people giving advice. Well, inflation is about wage push. If you have a good incomes policy, you can get away with this. Monetary policy in the works. That was just flat out wrong. The greatness of Milton Friedman was to convince people that was wrong. There's this paper by Edward Nelson, How Did It Happen? The Great inflation of the 1970s, and lessons for Today, where he goes through in great detail that the top economists back then, and these are mostly the Keynesians, they were just wrong.

[A]

Yeah, yeah, I'd agree with that. The whole idea of the cost push inflation seems crazy to me. I mean, it is true, of course, that the price of oil influences the price of steel, but steel is used to produce oil as well. So which one is cost? When which one is pushed? You have a simultaneous equation system here. You got your input output matrices, and everything's an input, and everything's an output. So why pick one thing out of that and say, well, this is the cost pusher, rather than, you know, just following along in a simultaneous equation system.

[B]

But here's my question, and I want to try to steel man these people, because we know they were very high iq, right? Samuelson, Tobin, all of them. And they did build models of their claims. Not as good as current models, you might say, but models nonetheless. Like, what exactly did they get wrong? Did they have some weird view that the demand for money is so stretchable or elastic that it just runs after wage demands from labor unions? Was that the mistake? If you look at demand for money in the early to mid-60s, it's not that stable. It's not actually fitting the Friedmanite model. So were they, in a sense right, but ultimately wrong? Or were they just flat out wrong? Or like, what is our model of the demand for money at that time, say the 60s leading up to the 70s? Inflation. It's far from clear to me what the best model of that is.

[A]

Yeah, I mean, they were dealing with very simplified models of macro aggregates instead of thinking about the price system and the operations of the price system. But I agree, it is peculiar that they should go so wrong on these questions. I mean, after all, they also understood general equilibrium.

[B]

Sure.

[A]

Now you could argue that, well, labor is a big commodity. Labor is a big factor in the economy, obviously. And maybe, you know, there are fixed price, fixed wage contracts.

[B]

So a lot more unions back then.

[A]

A lot more unions back then. However, I mean, that might hold if you're in, you know, the Netherlands or Denmark and you're making one, you know, labor plan for the entire economy. Right. In the US Context, even when there were fixed wage contracts over a period of years, they're not all established in the same month. Yes, right, so.

[B]

Or forced by law to be the same, as in some ways has been the case in France.

[A]

Yeah, exactly. They're not forced to be the same. So what happens then is, yeah, there's some fixed wage contracts, but some of them are made in January and others are made in July and yet others are made in December. So actually, overall, it's not even obvious that labor is fixed in price longer than some of the other commodities which are fluctuating in price more, you know, more on a daily basis. But still the price of labor is fluctuating a lot over a year. So I don't see any reason to pick labor out and say this is the cost pusher.

[B]

Reading those people, sometimes I get the impression the model was this. What really matters is inflationary expectations. What drives those are satisfied wage demands, which is not what a modern would say. People then, I mean, they in fact didn't know much about the money supply. Right. It just wasn't tracked the way it started to be tracked with Milton Friedman. So if inflationary expectations drive the demand for money and those expectations come from the agreed upon labor bargains, I'm not at all going to endorse that. It's just sort of ugly and jammed together and only picking out one possible causal chain. But maybe that's what they actually had in mind.

[A]

Maybe. But let's take a look at a more recent experience, which I think is also puzzling. But inflation expectations have a lot to do with it. We did manage to reduce inflation a lot of from 2021, 2022, when inflation was, I think, 7% at its highest. And we're now down.

[B]

No, it is 8.9%.

[A]

8.9% at the highest number. Yeah, yeah, yeah, okay, yeah. Yeah, we're now down, you know, to 3%. And we managed to do that without an increase in unemployment.

[B]

That's right.

[A]

So what do you take a as, how did this happen in the 2000 and twenties? But also what implications do you draw from that for our inflation experience of the 1970s? Why was it so different? Why did we require. We started out in 1981, 1982, the Volcker recession was a brutal recession. Unemployment increased a lot. We seemed to need that recession in order to decrease inflation, increases in unemployment, decrease in inflation. And yet much later, 2022, we were able to decrease inflation without a big increase in unemployment.

[B]

Well, it's interesting, in the last two years, as you know, all these people start coming out of the woodwork and saying, well, maybe the recession won't be so bad because wage demands have remained moderate. So it's this reemergence of the 1960s idea that I'd been scorning basically for my whole life. And then it's like, well, it's like one relevant factor again, maybe slightly rehabilitates the Keynesian view from the 60s, but I think there are a few factors. As to your question, why did we have a disinflation that wasn't so bad? One is just the initial setup in macro terms maybe was more like World War II and post World War II than like the 1970s. So because of the pandemic you had a kind of implied rationing and then a lot of pent up savings and also a lot of pent up borrowing. So the tightening didn't alter plans that much. And a lot of nominal demand flows could be pretty stable even with the tightening. Maybe there's some question begging in there, but it's a factor. And the other factor is just we've had roughly 2% inflation for a long time.

[A]

Yeah.

[B]

And people were thinking it's going to reemerge. So the expectations were rooted in a way that was not directly tied to the money supply the way Milton Friedman might have predicted. So that's this again, slight concession in the direction of these weirder 1960s theories where inflationary expectations come from the real side of the economy, these moderate wage demands, credibility of the Fed, but also related to the fiscal theory of the price level. Our fiscal policy has been a disaster and yet we got inflation under control. And the people who are full blown fiscal advocates for a theory of inflation, I don't see how they rationalize that.

[A]

Must be a lot of taxes coming in the future. Yeah, well, if you believe the fiscal theory. Yeah, Maybe there's multiple reasons for that.

[B]

Now my budget gets worse and you go from 9% inflation to something 2.5%, 3%. That's weird, even if you're not a dogmatic fiscal theorist. Right, yeah. Because you expect some monetization at some point. And in fact, we did it for a while right after the pandemic.

[A]

Yeah, absolutely. And there was no fiscal tightening which explained the reduction in inflation.

[B]

That's right. The contrary.

[A]

The contrary, yeah, exactly. Yeah.

[B]

No, politicians are talking about the big bipartisan commission to have the Grand Bargain and et cetera. Right. Neither party.

[A]

Right. So I would agree with most of that. Again, I don't buy into the wage moderation theory just because I don't see the idea of just picking out one commodity and saying this is the important one that drives all the others in a simultaneous equation system. That's just not true. Wage moderation itself is an example of why of inflation not getting out of control. It's not a reason, it is a factor. Right. Just like you wouldn't say, well, tuna prices didn't get out of control and that's what reduced inflation because the tuna prices were really low. Right. So I don't see any reason to privilege wages.

[B]

But if we're trying to steel man, this. Is there a partial move we can make, be Keynesian and say, at least for workers, spending is determined by the flows, not the stock corporations, Maybe it's like the net asset position in some more sophisticated way. And if worker spending is just from the flow, maybe the wage demands that are satisfied are predicting the flow of spending for the next few quarters because that's where flows are ruling the economy. And the other parts of the economy, it's stocks. I don't want to push that too hard, but again, if we're always trying to think, what grain of truth can we pull from this?

[A]

Yeah. I mean, the grain of truth that I would focus on would be expectations. And if you think that Jerome Powell, the Fed is going to get inflation under control, then you don't have to raise your prices so much and so forth and so forth. So I think expectations are important, and that is, I must admit, a funny thing to say, because expectations are one of the things which economists understand the least.

[B]

That's right. And there is something circular about it.

[A]

Yes, absolutely. Yes. In our sophisticated discussion, we can talk about expectations. In an unsophisticated discussion, which is really the same thing, we can talk about the vibes.

[B]

Exactly.

[A]

The vibes were better this time than in the 1970s. Yeah. Which does go to what you said earlier, which was that in the 1970s, and we're going to cover this later, so much more was also going wrong at the same time. That's right, right. Nixon was. You had Watergate, you had massive increases in crime, you had wars. Now, some of that is still going wrong today, and it does appear pretty chaotic today. But maybe in contrast, the public just felt that we were doing things, were more or less under control.

[B]

No. I started following the news in 1972, so I have memories of all this. They're definitely slanted, but my sense was people genuinely saw a change in regime. There was now a much higher probability that American ascendancy, ongoing high standards of living, was under some kind of permanent threat. Not that we would become a Third World nation, but that maybe it was all over, that Europe was going to catch up and exceed our standard of living. Even in this 1980 book I mentioned before, you know, you have taught people in here, both monetarists, Keynesians, market oriented economists, they're so worried about Europe catching up. It's like, hey, people like Message from the Future, you know. So I think that explains a lot about expectations. And in my view, from anecdotal experience, it was a very real thing. And I recall as a teenager being not petrified, but a bit like, hey, you screwed it all up just as I'm going to be looking for a job.

[A]

Right, right, exactly.

[B]

Yeah.

[A]

All right, well, let's sum up. Let me give you my bottom line, which you won't agree with, but I'll give you my bottom line, and that is that in the 1960s and the 1970s, the Keynesian economists abandoned things like balanced budgets. They abandoned the mythology of balanced budgets and they were proud of it. The problem was is that abandoning balanced budgets doesn't lead to countercyclical fiscal policy and economic stabilization, but rather to political business cycles, bigger governments and perpetual deficits. That's my bottom line. Take from this. Tyler.

[B]

Here's my bottom line. Alex A. It was good that we abandoned balanced budgets, though. We've gone way, way too far in the wrong direction. And the question is, could we have moderated that somewhat? Also, inflation was due to rise quite a bit due to the inevitable collapse of Bretton Woods. With that process, we also went way, way too far because the Fed was badly advised and for political reasons made a bunch of mistakes. The question again is, could we have then moderated that better? And the overall lesson I think I would draw is a bunch of things that are bad or sometimes inevitable. And the key questions are, can we get some more moderated versions of these things? It seems to me that's not discussed and researched enough. That's one of my bottom lines from all this.

[A]

All right, thank you, Tyler.

[B]

Thank you, Alex.