Arthur Burns and inflation.

Arthur Burns, Chairman of the Federal Open Market Committee (FOMC) of the Federal Reserve System (the Fed) from February 1970 until December 1977, was fiercely opposed to inflation. For the public, and especially for the business community, Burns embodied opposition to inflation. Nevertheless, during his tenure as head of the Fed, high rates of inflation became a pervasive fact of American life. How could that have happened?

The puzzle is especially striking as Burns became Chairman with an extraordinarily distinguished background as an economist. He had been president of the American Economics Association and had headed the prestigious National Bureau of Economic Research (NBER) since the late 1940s. As head of the NBER, Burns gained worldwide recognition as the leading scholar of the business cycle. based on his work on the business cycle, he concluded that inflation itself sets in train forces that cause recession. As an economist, how did Burns think? How did he shape the data he studied into a coherent view of the world - a view that could lead him far away from the control of inflation?

1. EXPLAINING MONETARY POLICY

To explain monetary policy, one requires more than an understanding of the views of the Chairman of the FOMC. One must understand the general political and intellectual environment of the time as well. If Burns had been Chairman in another era, say, in the 1950s or 1990s, the environment, and therefore monetary policy, would have been quite different. So to attribute the inflation of the first part of the 1970s solely to Burns's leadership is wrong.

Monetary policy under Burns's FOMC was never as expansionary as vocal congressmen urged and, through 1972, was less expansionary than the Nixon Administration desired. In fact, throughout his tenure, monetary policy was consistently less expansionary than desired by Keynesian economists, who represented mainstream economics. Indeed, at the time, Fed economists joked that policy must be on track because it was more expansionary than monetarists desired but more restrictive than Keynesians desired. The inflation of the 1970s represented the failure of an experiment with activist economic policy that enjoyed widespread popular and professional support. Burns was part of a political, intellectual, and popular environment that expected government to control the economy.

In the early 1970s, the political system and the economics profession agreed that 4 percent was a normal rate of unemployment. Both the political system and a majority in the economics profession accepted that the government was responsible for keeping the unemployment rate to 4 percent or less through activist monetary and fiscal policy. Burns accepted this consensus view. And he added a sense of urgency to it. At the time, the United States was riven by the socially divisive issues of race and the Vietnam War. When the unemployment rate rose in 1970 to 6 percent, Burns believed that the country needed a combination of policies that would simultaneously restore price stability and full employment.

In November 1970, the minutes of the Board of Governors show Burns telling the Board (Board Minutes, 11/6/70, pp. 3115-17) that

. . . prospects were dim for any easing of the cost-push inflation generated by union demands. However, the Federal Reserve could not do anything about those influences except to impose monetary restraint, and he did not believe the country was willing to accept for any long period an unemployment rate in the area of 6 percent. Therefore, he believed that the Federal Reserve should not take on the responsibility for attempting to accomplish by itself, under its existing powers, a reduction in the rate of inflation to, say, 2 percent . . . . he did not believe that the Federal Reserve should be expected to cope with inflation single-handedly. The only effective answer, in his opinion, lay in some form of incomes policy.

(The term "incomes policy" is a catchall expression for various forms of direct intervention by the government to control prices.) Those comments reflected a reading of the domestic situation that was particular to the time. Again, a different time would have yielded a different monetary policy.

To blame the inflation of the 1970s on an individual or on a group of individuals is too facile. At the same time, monetary scholars can still learn from the mistakes of individuals - in this case, they can comprehend how Burns understood the world as an economist. By doing so, they can put into place a piece of a larger puzzle, which when completed explains the inflation of the early 1970s.

Attributing policy failures to personal failures is a mistake that keeps one from learning. In this respect, it is helpful to view the high inflation of the 1970s as part of a learning process. The current consensus that central banks are responsible for inflation would have been impossible to establish in the intellectual environment of the 1970s. However, the "learning" view itself is incomplete. It does not explain why inflation was low in the 1950s. Presumably the state of economics was not more enlightened in the '50s than in the '70s. Also, experience in itself does not make people wise. Economists need to examine and learn from historical experience to avoid repetition of mistakes.

Economists use models to learn about the world and to explain how it works. A model imposes a discipline by forcing the economist to explain cause and effect relationships within a framework that yields testable implications. When experience falsities those implications, the economist must return to the model and examine its failures. The economist cannot "explain" the model's failure to predict by assuming that the world's underlying economic structure changes in an ongoing, unpredictable way. The evidence from Burns's own words shows that he did not use such a model to predict inflation and, consequently, failed to learn from the inflationary experience of the 1960s and 1970s.

How did Burns view macroeconomic policy as an economist? Most generally, Burns had a credit view of monetary policy. That is, monetary policy worked through its influence on the credit market. However, monetary policy was only one factor affecting credit markets. At times, in its influence on inflation, monetary policy could be overwhelmed by other factors. More specifically, Burns had a real or nonmonetary view of inflation. That is, inflation could arise from a variety of sources other than just money. He believed that a central bank could cause inflation by monetizing government deficits but did not attribute inflation to that source in the early 1970s. Instead, he attributed it to the exercise of monopoly power by unions and large corporations.

If conventional monetary policy weapons were powerless to deal with these forces, then perhaps direct controls might work. Accordingly, President Nixon imposed wage and price controls August 15, 1971. The experience with such constraints offered a tailor-made experiment of Burns's views. The controls worked as intended in that they held down wage growth and the price increases of large corporations (see Kosters [1975]). Nevertheless, inflation rose to double digits by the end of 1973. So Burns attributed inflation to special factors, such as increases in food prices due to poor harvests and in oil prices due to the restriction of oil production. However, special factors are by nature one-time events. In 1974, inflation should have fallen as the effect of these one-time events .dissipated, but it remained at double-digit levels that year. Burns then blamed inflation on government deficits. Although those deficits were small in 1973 and 1974, Burns was able to make them look larger by adding in the lending of government-sponsored enterprises like the Federal National Mortgage Association.

For Burns, the source of inflation changed regularly. He believed this view only reflected the complexity of a changing world. As a consequence, he did not have a model of inflation that could be contradicted by experience. Where did his views as an economist originate? They came most importantly from Wesley Clair Mitchell.

2. WESLEY CLAIR MITCHELL

To understand Arthur Burns, it is necessary to see him as standing astride two worlds in economics: an earlier American institutionalism and the now-dominant neoclassical school. Burns was the protege of the American institutionalist and founder of the NBER, Wesley Clair Mitchell. While working on his Ph.D. at Columbia in 1930, he attracted Mitchell's attention. Burns became Mitchell's student and, later, his collaborator. In 1946, they published a comprehensive study of the business cycle, Measuring Business Cycles. A year before, when Mitchell retired, Burns had become director of research of the NBER. Both achieved worldwide recognition as preeminent scholars of the business cycle. In his thinking about the business cycle, Burns was greatly influenced by Mitchell's views.

As a student at the University of Chicago in the 1890s, Mitchell studied under Thorstein Veblen, John Dewey, and the anti-quantity theorists, J. Laurence Laughlin and Adolph Miller. Miller, who became one of the original members of the Board of Governors of the Federal Reserve System, was the staunchest defender of the real bills doctrine in the 1920s and 1930s. (According to the real bills doctrine, central banks maintain price stability by preventing the speculative extension of credit, not by controlling the quantity of money.)

Mitchell, an anti-quantity theorist himself, attacked the quantity theory in his book History of the Greenbacks. He observed that the gold value of greenbacks - the North's paper currency - fluctuated with the military fortunes of the North and concluded that their value depended not on the quantity in circulation, but rather on the probability that the North would redeem them in gold (Burns [1949] 1954). In this work, Mitchell first developed his central idea that business cycle dynamics derive from lags in the adjustment of prices of different classes of goods and factors of production and the effects of those lags on business profits. …

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