A History of the Federal Reserve, Volume 2 (44 page)

Again, as with President Nixon’s price and wage controls, the proposal blamed unions and business, not government policies for inflation. And again, the underlying belief was that the way to reduce inflation was to change union and management actions without adopting restrictive policy. Surprisingly, Schultze described the proposal as “the only hope for moderating inflation” (ibid., 6). In a later memo, he considered variations on this proposal and alternatives, including guidelines and reduced aggregate demand by monetary and fiscal actions. He rejected the latter as too costly.
⁸⁸

Second, many members of FOMC, including Burns, either were reluctant to reduce money growth enough to lower inflation because of concern for recession or did not believe that money growth was a main cause of inflation. When Burns wrote to President Carter offering a twenty-point anti-inflation program, he did not mention monetary policy. He emphasized reductions in federal spending, tax policy to encourage investment, deregulation of transport, vigorous enforcement of anti-trust laws, public hearings on price and wage increases, and reduction of the minimum wage for teenagers (memo, Burns to the president, Schultze papers, Carter Library, Box A96-O1B, March 31, 1977).

Most of Burns’s proposals had one-time effects on the price level that would appear as a temporary reduction in the inflation rate. Burns never distinguished between permanent and temporary reductions in aggregate spending. He blamed unions and budget deficits for inflation and only occasionally mentioned money growth.

Third, this was not his only analytic error. He did not develop adequate procedures for controlling money growth. Even when there were large errors, as when the FOMC planned for 8 percent money growth in April 1977 and experienced 20 percent growth, it did not improve procedures. The staff “explained” most of the errors by saying that the demand for
money shifted. They did not admit that better control procedures might have warned them that the funds rate had to fluctuate over a wider range. They did not want to admit that answer because they believed that frequent changes in interest rates would disturb the money market and thereby damage the financial system in ways that they never explained. The Federal Reserve again chose protection of the money market instead of protection of the public.
⁸⁹

88. Burns told the House Banking Committee in July that inflation could not proceed without “monetary nourishment;” but he explained that the Federal Reserve could not act quickly. “The shock of abrupt adjustment after so many years . . . would be excessively risky” (Burns statement, Carter papers, Jimmy Carter Library, July 29, 1977). This view contrasts with the administration’s approach as soon became apparent. In Schultze’s absence, Lyle Gramley, a member of the Council and a former Federal Reserve senior staff member, told the president that prolonged growth of the money stock at current rates would have adverse effects eventually but he opposed an increase in interest rates at that time (memo, Gramley to the president, Carter Library, August 11, 1977). Eizenstat urged the president to call Burns to oppose any interest rate increase.

In January 1978, with the dollar falling and inflation rising, Schultze sent a memo to President Carter proposing a new set of guidelines for wage and price increases as part of an overall program of fiscal restraint, improvements in productivity, and reduction in excise taxes. There is no mention of monetary policy. He did not mention his earlier proposal to lower tax rates as an incentive to lower wage and price increases.

President Carter accepted the program with considerable skepticism. He wrote on the cover page: “Charlie. The program seems (inevitably I guess) very general in nature and mostly wishful thinking. However, I’ll do all I can to make it successful” (memo, Schultze to the president, Schultze papers, Carter Library, Box A96–01B, January 7, 1978).

In 1977, the United States ran the largest current account deficit up to that time. Much of the increase represented the arithmetical effect of higher oil prices. The cost of oil imports rose from $8 billion in 1973 to $47 billion in 1977. The large current account deficit and increased inflation induced a fall in the dollar. In the first year of the new administration, the trade-weighted dollar fell from 105 to 97, more than 7.5 percent. Depreciation against the mark reached 13 percent, and 29 percent against the yen.

The administration program called for coordinated fiscal expansion by the United States, West Germany, and Japan. The metaphor was that these countries would be the locomotive of the world economy, raising growth everywhere without much change in currency values. Trading partners, particularly Germany, complained about dollar depreciation, but they were reluctant to join in coordinated expansion. They could either purchase the dollars to finance the current account deficit, permit additional exchange appreciation, or try to sterilize the inflow. Germany, especially, would not sterilize the dollar inflow, so it missed its monetary target (by 100 percent in fourth quarter 1977) (Biven, 2002, 116). In December 1977 and January
1978, the United States, under foreign pressure, intervened. It increased its swap lines with Germany and raised the federal funds rate and the discount rate, and the president announced that the United States would intervene to prevent disorderly markets (ibid., 120).
⁹⁰
At the February FOMC meeting, Henry Wallich argued that there was too much intervention, but Burns argued that it was necessary to prevent additional dollar depreciation (Burns papers, tape 2.1, February 1978). Later, he reversed his position, saying that intervention delayed more fundamental steps to restore the integrity of the dollar (ibid., 2.5).

89. As often happens in government, some staff tried to find personal motives for Burns’s differences with the administration. A staff member wrote to the president that interest rate increases were “bringing the economy down.” Burns thus appears as the “inflation fighter” making the president look bad and responsible for the decline in the stock market (memo, De Jongh Franklin to the president, Carter Library, November 2, 1977). The memo suggests the bad feeling between Burns and the White House staff.

In Burns’s last three months at the Board consumer prices rose 7.1, 7.7, and 8.9 percent (at annual rates). Inflation control became a more lively issue. In advance of the February 22 Quadriad meeting, Schultze told the president that growth of monetary velocity had fluctuated over a wide range. The Federal Reserve should therefore widen the bands on money growth, but should avoid further interest rate increases. He blamed “institutional factors” such as the increased minimum wage and higher payroll taxes for the rise in inflation. And he added, “It would be most unfortunate to sacrifice real output objectives in the name of inflation control without giving your anti-inflation program a real test” (memo, Schultze to the president, Schultze papers, Carter Library, February 21, 1978, 3). The antiinflation program refers to the voluntary guidelines recently adopted.
⁹¹

Soon afterward, Schultze sent the president a tutorial on inflation, its causes, and the reasons it continued despite persistent unemployment. The main reason he gave was that in modern economies prices and wages are not very sensitive to modest and short-lived periods of economic slack. “Once an inflation has been underway for a while, workers and employers behave as if it will continue. . . . It therefore is very difficult to use the traditional tools of monetary and fiscal policy to bring inflation to a halt once it has begun in earnest” (memo, Schultze to the president, Schultze papers, Carter Library, March 14, 1978, 5). Schultze explained the persistence of inflation by citing downward inflexibility of prices and wages. Each new round of inflation started from a higher base. He did not relate the down
ward inflexibility to the belief that the Federal Reserve and the government would end efforts to reduce inflation when unemployment rose. But he mentioned more widespread expectations of continued inflation as one of the reasons for persistence. And he expressed concern about the long-term trend toward higher inflation. “As we move toward lower rates of unemployment, increasing labor market tightness will, at some point or other, lead to an acceleration in the rate of advance of wages” (ibid., 13).

90. The report on foreign exchange operations in February acknowledged that the desk exceeded its authority by purchasing more than $100 million in gross transactions per day. The FOMC set limits on gross and net transactions (Burns papers, tape 1, 13; February 1978).

91. The administration considered, but opposed, Senator Proxmire’s bill to consolidate the bank regulatory agencies into a single banking agency. The bill passed the Senate but not the House. Eizenstat and Schultze gave some reasons for not taking up the proposed reform at that time. One reason was that they believed that Congress would increase “detailed regulation that substitutes for market competition—exactly the opposite direction from the thrust of your other regulatory reform initiatives” (memo, Eizenstat and Schultze to the president, Schultze papers, Carter Library, March 8, 1
978, 4).

Two days after Schultze’s tutorial, Blumenthal and Schultze told the president that “the price outlook is deteriorating.” They warned the president that consumer prices would rise 7 to 7.25 percent, about 1 percentage point more than their earlier forecast. (The twelve-month average rate reached 8.6 percent in December 1978.) “Absent other convincing antiinflation programs, the classic resolution of the inflation problem is likely to take the form of tightening financial markets, even with the Federal Reserve lagging rather than leading the market” (Blumenthal and Schultze to the president, Schultze papers, Carter Library, March 15, 1978, 3). To prevent this outcome, Blumenthal and Schultze proposed: (1) reduced wage increases for federal employees, (2) asking state and local governments to reduce wage increases and lower sales and property taxes, (3) other similar actions to delay increases or reduce prices in regulated industries. They also proposed that the president meet with unions and businesses to urge moderation and especially smaller executive compensation increases.

APPOINTMENT OF G. WILLIAM MILLER

President Carter’s advisers opposed Burns’s reappointment to a third term as chairman. In December 1977, Blumenthal and Schultze sent the president a memo describing the qualities that a chairman should possess. It was an anti-Burns memo, critical of Burns’s weights on inflation and unemployment. Among other comments, they said, Burns was “more concerned with inflation than unemployment”; he was willing to “thwart administration goals to reduce unemployment”; and he “has stirred up opposition to many of your policies.” “We should not expect a Fed chairman to follow an administration policy line, but he should work closely with us” (memo for the president on The Role of the Federal Reserve, Box 16, R. J. Lipshitz Files, Carter Library, December 10, 1977, 1–2).

Burns had openly opposed the administration’s initial fiscal program. Also, he gave speeches about the dangers of inflation, though he did not run restrictive policy for long. Schultze criticized his lack of cooperation. At meetings, Burns commented on administration policies, but citing independence, resisted talking about Federal Reserve policy or accepting comments (Schultze, 2005).

Washington gossip at the time cited Burns for reluctance to act as a team member with Carter’s officials, his less-than-satisfactory relations with Secretary Blumenthal, and his decision to raise interest rates in 1977. Gossip also cited his decisions to control money growth and emphasize disinflation despite his failure to implement these policies. Burns tried hard to get reappointed. He wanted to be reappointed by a Democrat, perhaps to remove the charge that he had used monetary policy to reelect President Nixon. When Hubert Humphrey, a friend of Vice-President Walter Mondale’s, made a very critical speech about Burns’s policy, he recognized that he would be replaced (Guenther, 2001, 10–11).
⁹²

Carter put Mondale in charge of the search. Mondale’s search narrowed the choice to three industrialists and one economist. G. William Miller, CEO of Textron, had been active in Democratic Party politics. Miller had served as a director of the Boston Federal Reserve bank, a position that gave him exposure to and limited understanding of Federal Reserve activities. He had headed a successful business group that found employment for Vietnam veterans, and had taken a minor but active role in the 1976 campaign. Reginald Jones of General Electric was “conservative,” but he was also “expansion minded about economic growth and cooperative.” Irving Shapiro of Dupont, and Bruce MacLaury of the Brookings Institution were the other two (memo to the president on the Federal Reserve Chairmanship, the Federal Reserve Board, Box 16, Carter Library, December 23, 1977). The advisers liked all of the candidates, including those who said they lacked enough knowledge of monetary matters. The critical attributes were acceptability to the business and financial community and willingness to “work cooperatively with the Administration while preserving the independence of the Fed” (ibid., 1).

They chose Miller, perhaps because “Miller shares your basic goals and views. He would be an independent Chairman, but he would also be cooperative and easy to work with” (ibid., 4). Miller, however, was concerned about his lack of knowledge and background. The memo dismissed this statement. He “can learn the job quickly; he will have a good staff available; there are no arcane mysteries which would elude him” (ibid., 4).

Miller had spoken about inflation and unemployment months before he was considered for appointment. He believed that fiscal and monetary policies could reduce the unemployment rate “from 8 percent to 5.5 percent (or perhaps even 5 percent) within two years without triggering a renewed bout of inflation” (quoted in Romer and Romer, 2003, 29). At his Senate
confirmation hearing, Senator Proxmire expressed strong opposition. He thought Miller lacked knowledge needed for the job

92. Burns hired Milton Hudson from JP Morgan to lobby financial institutions to support Burns’s reappointment (Guenther, 2001, 11).