A History of the Federal Reserve, Volume 2 (45 page)

At his confirmation hearing Miller denied that the standard Phillips curve gave the tradeoff between inflation and unemployment because it included workers who received unemployment compensation as unemployed. Miller thought they should be counted as employed. “A significant portion of the unemployed act in an economic sense as if they were employed” (ibid., 30). Hence, expanding to return them to work would not greatly change the inflation rate. This argument must have appealed to the expansionists like Eizenstat in the Carter administration. However, Miller did not give greater weight to unemployment than to inflation. When asked about his priority, his answer was “we can tackle both to achieve what we really need—full employment with price stability” (“Swearing in William Miller,” Box 19, Carter Library, March 8, 1978, 4). This appealing answer was not entirely consistent with his earlier statements.

Burns stayed on at the Federal Reserve to ease the transition but left before the March meeting. Miller took the seat of David Lilly, who resigned as governor in February 1978 after serving twenty months. Miller served for only seventeen months before becoming treasury secretary.

Miller’s conjecture about inflation proved incorrect. In Burns’s last month, February 1978, the unemployment rate was 6.3 percent, and the twelve-month CPI inflation rate was 6.2 percent. The GNP deflator rose at a 5.9 percent annual rate in that quarter. When Miller left in August 1979, the unemployment rate was 6 percent, and CPI inflation reached 11 percent. This rate included the one-time effect of an oil price increase. The GNP deflator is less affected by oil price change; it reached 8.5 percent in third quarter 1979.

Burns had not reduced the inflation rate during his eight years as chairman, but under Miller inflation increased. The irony of the decision to replace Burns because he was regarded as uncooperative and independent was that a more independent Paul Volcker soon after replaced Miller. Poole (1979, 484) summed up Burns’s leadership of the Federal Reserve: “The tragedy of Burns’s leadership . . . is that he did not put in place the monetary policy he advocated so vigorously. . . . Arthur Burns’s Federal Reserve policy permitted money growth zigzags to accumulate to produce one of the most inflationary policies over an eight year period of any eight year period since the establishment of the Federal Reserve System.”
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93. After leaving the Federal Reserve, Burns chaired the Committee to Fight Inflation. The members were distinguished former policy officials of both parties. Their reports rec
ognized the importance of monetary control. It excused Federal Reserve actions. “The ability of the Federal Reserve System to combat inflation has in the past been limited by lack of understanding and support in the Congress” (Committee to Fight Inflation, 1980, 3).

Carter administration policy added to the problem. Looking back, Stuart Eizenstat, the president’s Chief Domestic Policy Adviser, acknowledged several mistakes. The biggest mistake was underestimating the economy’s strength in 1976 and the underlying rate of inflation. Treasury Secretary Blumenthal was the first inside the administration to urge a policy shift, but he left before it could be accomplished (Eizenstat, 1982, 79–84).

Miller’s lasting achievements as Federal Reserve chairman were legislative. To accomplish regulatory changes, Miller had to improve working relationships with Congress. In 1978, Congress passed the International Banking Act, placing foreign banks and branches in the United States under rules similar to those applied to domestic banks. Miller worked with Congress to get changes in the Humphrey-Hawkins Act that made it acceptable to the Federal Reserve. And he worked with Congressman Henry Reuss on the Depository Institutions Deregulation and Monetary Control Act (DIDMCA), which authorized reserve requirements for non-member banks and phased out interest rate controls including regulation Q. Miller had moved to the Treasury before DIDMCA passed, but he was a major influence on its development and passage. The act led to expansion and modernization of United States financial institutions.

POLICY ACTIONS 1978–79

As mentioned, the administration decided at its inception that it did not favor use of monetary and fiscal policy to reduce inflation. The cost in higher unemployment and lost output seemed too great. Instead it proposed voluntary wage-price moderation as part of its April 1977 program.
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Schultze later said, “We had an anti-inflation program, so-called, in April 1977 . . . none of which meant anything” (quoted in Biven, 2002, 134). By the time Miller took office, inflation had increased and the program was dead. The administration blamed increases on food prices. Real wages rose slowly, but productivity slowed even more, so unit labor costs rose more than 8 percent in the year ending first quarter 1977 (memo, Schultze to Carter, Carter Library, Box 194
, May 11, 1977).

94. The program included extension for two years of the Council on Wage and Price Stability (COWPS), which had administered President Nixon’s wage and price controls. Also, the program called for deregulation of communications, trucking, and other industries. This was one of the more successful economic initiatives taken during the Carter presidency. While governor of Georgia, Carter had listened to a Georgia economist who now advised him that jawboning and guidelines would not work, so he was not surprised that guidelines failed.

At his first FOMC meeting, March 21, 1978, Miller told the members:

We have all these policy dilemmas we are speaking about. Relative growth rates are such that we are going to have these large current account deficits. Then our choices are going to narrow down to whether we’ll take a lower growth rate in our economy because it doesn’t look like we are getting the relative speedings in other economies. [A lower growth rate] is something that I think many of the economic advisers in the Administration are now willing to accept because the alternative is to see the dollar under pressure and our resources to change it are not great. And that in itself feeds inflation into our economy and creates a whole series of other [developments] that lead us down an unhappy trail. (FOMC Minutes, March 21, 1978, 9)

Governor Partee expressed “amazement” that the administration would favor a lower growth rate. President Eastburn (Philadelphia) suggested that a recession might be needed. Wallich insisted on the need to reduce inflation. No one pointed out that lower growth during a recession would produce mainly a temporary reduction in current account balances. The effect on the exchange rate was uncertain.

In April 1978, Blumenthal and Schultze sent a memo on inflation that began on an ominous note. “During the past several months, a growing concern has developed around the country about the outlook for inflation. Your April 11 announcement of steps to implement the anti-inflation program was an important step in dealing with the inflation problem. Realistically, however, the chances are no better than 50–50 that the anti-inflation program will lead to significant moderation of wage and price increases— even if it is followed up vigorously and continuously” (memo, Schultze and Blumenthal to the president, Schultze papers, Carter Library, April 13, 1978).
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A memo to Vice President Mondale reported adverse polling data. The president’s rating on managing the economy had fallen from 47 percent to 24 percent. “Moreover, other recent polls show a dramatic shift in public concern over inflation as opposed to unemployment” (quoted in Biven, 2002, 137). This proved to be a step on the path to monetary restraint.

The Carter administration was incapable of devising a successful strategy for reducing inflation. Labor unions, an important support group, op
posed both wage controls and guidelines and higher interest rates. Business groups would accept price guidelines only if unions accepted wage restrictions. That would have been a program, but inflation can be hidden but not ended by such means. The administration wanted tax reduction, not an increase, in 1978. And it opposed raising interest rates enough to slow inflation. Its efforts consisted of cosmetic actions and the hope that they might succeed. Unfortunately for them, public opinion now saw inflation as a major problem.
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Schultze (2005) recognized the problem, hoped to enforce the guidelines with greater effort, but he recognized that other effective actions had been ruled out by concern to avoid increasing unemployment.

95. The new program followed the program outlined in the 1978 Economic Report. Voluntary steps to decelerate wages and prices sector by sector, reductions in government wage increases to set an example, etc. Robert Strauss, a persuasive Texas lawyer, became counselor on inflation to persuade business and labor. Large corporations offered cooperation. The AFL-CIO did not (Biven, 2002, 137–38). And the coal miners negotiated a three-year 38 percent increase in wages at this time.

The choice of Miller added to the problem of controlling inflation. George Meany, president of the AFL-CIO, wrote the president quoting and endorsing Miller’s approach enunciated in a 1974 interview.

Working our way out of inflation requires an allocation of the available but limited resources to areas of priority, thus reestablishing a proper balance between supply and demand. Allocation solely by controlling the aggregates— the supply of money and net federal spending—will bring about levels of unemployment and general economic hardship that are likely to be unacceptable. Allocation by direct controls involves even more difficulties. (letter, George Meany to the president, Schultze papers, Carter Library, May 19, 1978)

Meany added that Miller saw the need for a new approach, mainly selective controls including credit controls. He agreed. President Carter later requested the Federal Reserve to impose such controls.

Miller had apparently changed his mind. In his first press interview he explained that the Federal Reserve must achieve “a gradual slowdown in the expansion of the money supply” (Rowe, 1978). Miller also supported the president’s program to moderate price and wage changes. And he recognized that shifting from unemployment to inflation would not achieve both objectives. “Society can not reach the goals of full employment growth and price stability independently” (ibid., D10).
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96. An example is a fourteen-page memo to the president signed by Schultze and Blumenthal dated April 13, 1978. Near the end of the memo, a White House staff member wrote about the recommendations. “This is an anti-climax . . . they say don’t do anything. This is absurd” (memo, Schultze and Blumenthal to the president, Schultze papers, Carter Library, April 13, 1978, 14).

97. On his last day at the Federal Reserve, Arthur Burns spoke about inflation and the dollar. He favored pay cuts for government employees, an energy conservation policy, and tax cuts to increase investment. He also favored “massive intervention” to strengthen the dollar, supported by sales of gold, SDRs, and $10 billion of bonds denominated in foreign currencies (Rowan, 1978, A2). Burns placed greater importance on avoiding currency depreciation
than on curtailing domestic inflation. In November, the administration adopted several of his proposals.

The Federal Reserve began to raise the federal funds rate in May 1978.
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The monthly average rate rose from 6.9 to about 10 percent that year. At the time, the FOMC set annual growth rates for the monetary aggregates and two-month average growth rates for M
₁
and M
₂
. It specified a federal funds rate believed compatible with the money growth rates. If a discrepancy arose, the committee held a telephone meeting to assess the situation. During 1978, the planned two-month money growth rates changed very little. Actual M
₁
growth reported in the minutes rose as high as 19 percent (April), 11 percent (August), and 14 percent (September) without any decisive effect on FOMC actions. Most of the time M
₁
and M
₂
desired growth rates were 4 to 8 or 9 percent and 5 to 9 or 6 to 10 percent respectively. Table 7.12 shows the monthly average federal funds and monthly CPI inflation rates during Miller’s term as chairman. Average federal funds rates were, as before, very close to policy rates specified by the FOMC.
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98. The minutes obtained from Burns’s papers end when he left the Federal Reserve in March 1978. For the rest of 1978, we relied on the Annual Report supplemented by the minutes for May to December 1978 that Debby Danker made a special effort to edit and release in 2007. We greatly appreciate her effort.

99. At the April meeting, the FOMC had an active discussion of a proposal by President Baughman (Dallas) that the FOMC announce a three-year target for money growth. Only Roos (St. Louis) supported him. The Subcommittee on the Directive opposed because they
said no one would believe that they would achieve the three-year growth rate. Baughman argued that the FOMC needed to meet long-term objectives, but he argued in vain. In 2007, the Federal Reserve adopted the proposal as part of a plan to become more transparent.