Kenneth M. Emery

English

Research Papers in Economics

4
NOTE: Data through March 1993.
SOURCE: Bureau of Labor Statistics, Consumer Price Index.
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’92 ’90 ’88 ’86 ’84 ’82 ’80 ’78 ’76 ’74 ’72 ’70 ’68 ’66 ’64 ’62 ’60 ’58 ’56 ’54 ’52
ECONOMIC
COMMENTARY
by
Kenneth M. Emery
Senior Economist
Federal Reserve Bank of Dallas
banks began to doubt the U.S. commitment to convert
dollars into gold. During the late 1960s, U.S. gold stocks
began to dwindle as foreign central banks converted
their dollar holdings into gold. Finally in 1971 as U.S.
gold stocks waned, President Nixon suspended con-
vertibility, and the world’s industrialized countries
moved to a monetary system of flexible exchange rates
that remains in place to this day.
Controlling Inflation: A Historical Perspective
A
lthough inflation in the United States has been
moderate and stable during the past few years,
history offers us no guarantee that such stability will
continue. Just how fragile is the current situation? There
are no simple answers, but history suggests that our
current monetary regime requires unwavering central
bank vigilance if the value of our nation’s currency is
to be maintained. This lesson underscores the impor-
tance of Federal Reserve independence.
U.S. inflation rates for the post–Korean War period
are plotted below. On the basis of several economic
and political events, the behavior of inflation over this
period can be divided into three periods: 1953–71,
1972–82 and 1983–93.
The first period, which extends from the end of the
Korean War through 1971, reflects inflation rates that
were low and stable until the late 1960s. During this
time, the United States operated under the Bretton
Woods monetary system whereby other countries
pegged the value of their currencies to the U.S. dollar.
The dollar, in turn, was convertible into gold at $35 per
ounce. This system worked well as long as the United
States maintained the supply of dollars relative to gold
consistent with this price.
As the costs of the Vietnam War and the Great
Society programs escalated, however, the U.S. govern-
ment financed much of these costs by printing more
dollars, as well as by creating more government debt.
Consequently, the supply of dollars increased world-
wide as Americans traded goods and capital with other
countries. As foreigners converted their dollar holdings
into their domestic currencies, many foreign central
U.S. Inflation Since the Korean War
(Four-quarter moving average)
Percent
This document was digitized and made available by the Federal Reserve Bank of Dallas' Historical Library (FedHistory@dal.frb.org).5
The second period depicted in the chart extends
from 1972 until 1982. After 1971, there was no real
commodity, like gold, backing the value of the dollar.
Without the discipline this backing had imposed on
money growth, the responsibility for maintaining the
value of the nation’s currency
fell entirely to the policymakers
at the Federal Reserve. Unfor-
tunately, two developments
made this responsibility diffi-
cult to fulfill. First, during this
period many influential
macroeconomists thought a
stable trade-off existed be-
tween economic activity and
inflation. Furthermore, these
economists believed that fis-
cal and monetary policies
could be used to exploit this
trade-off. Policymakers at the
Federal Reserve were swayed
by these views and increased
the money supply at a rate too
rapid to be consistent with
low or moderate inflation. Sec-
ond, several large oil-price
shocks during the 1970s put
upward pressure on the price
level and downward pressure
on the potential growth of real
economic activity. The Fed-
eral Reserve attempted to
counter the real effects of these shocks with higher
money growth, which only exacerbated inflation.
As inflation accelerated during the 1970s, many
economists began to recognize the extent of inflation’s
harmful effects on economic growth and began to
doubt the existence of a stable trade-off between
economic activity and inflation. Economists recog-
nized that a nation’s rate of growth is determined by the
goods and services that private industry produces, not
by the amount of paper currency government prints.
Simply put, money printed is not money earned.
In 1979, President Carter named Paul Volcker chair-
man of the Federal Reserve and gave him a mandate to
bring inflation under control. Under Volcker, the
Federal Reserve initiated policies to lower the inflation
rate by more directly controlling the growth rate of the
money supply.
By the early 1980s, these policies had led to sub-
stantially lower inflation, which is reflected in the chart.
Over the past decade, policymakers at the Federal
Reserve have maintained their resolve to keep inflation
low. This resolve is partly the result of the view that
maximizing potential output
and employment growth en-
tails avoiding the damaging
effects that high and variable
inflation can have on invest-
ment, productivity growth
and, more generally, the price
system as an allocative
mechanism.
Although policymakers at
the Federal Reserve are re-
solved to keep inflation low
and stable, there will always
be outside pressures for easy
money policies. This is espe-
cially true when large govern-
ment deficits create the
temptation to substitute gov-
ernment currency for govern-
ment debt. Easy money
policies, however, only result
in potential short-term gains
at the expense of long-term
growth.
The lesson to learn from
our monetary history is two-
fold. First, the move to a cur-
rency that is not backed by a real commodity requires
that the Federal Reserve be insulated from outside
pressures. These outside pressures often originate
from those who have short-term interests in conflict
with our nation’s long-term welfare. Second, policy-
makers at the Federal Reserve must make price stability
their primary goal. Maintaining the value of our nation’s
currency is the most important contribution the Federal
Reserve can make to maximizing our nation’s potential
output and employment growth.
If we have learned what history teaches, future
historians will view the 1970s as an aberration: a period
when a central bank and a nation learned about the
discipline required to maintain the value of a currency
that is not convertible into a real commodity.
“Although
policymakers at
the Federal Reserve
are resolved to
keep inflation low
and stable, there
will always be
outside pressures
for easy money
policies.”
This document was digitized and made available by the Federal Reserve Bank of Dallas' Historical Library (FedHistory@dal.frb.org).

Controlling inflation: a historical perspective

http://dallasfed.org/assets/documents/research/swe/1993/swe9304b.pdf

Controlling inflation: a historical perspective

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