Camelot:

  The initial stages of inflation are very attractive. That's why governments love it so much.
 &

  Political leaders love the budgetary deficits and monetary inflation of the early stages that enable them to do what they want at the moment and put off until after the next election or the end of the regime so much of the hard decisions. All that is required is intentional denial of the inevitable consequences demonstrated repeatedly during 2500 years of economic and monetary history.
 &

By 1970, the financial world was crumbling underfoot - and the Keynesians - like the sorcerer's apprentice - were learning that they could not actually control the forces that they had let loose.

  The Keynesians in the Kennedy/Johnson administration were true believers in an absurd rationalization that provided intellectual justification for the administration's irresponsible inflationary monetary and budgetary policies. They were appointed to influential policymaking positions where they proceeded to undermine the financial health of the strongest financial system in world history. From these influential and prestigious positions, they came to dominate the academic and professional field.
 &
  The initial stage during the first term of the Kennedy/Johnson administration was pleasant indeed, and the worst of the inflationary impact was put off until the end of the decade of the 1960s when it was the problem of the Nixon administration. In that respect, it fulfilled all that politicians desire.
 &
  Meltzer tells of a decade that began with Camelot and ended with Gone With The Wind. There was almost nine years of rapid economic growth - the longest period of sustained growth up to that time. However, by 1970, the financial world was crumbling underfoot - and the Keynesians - like the sorcerer's apprentice - were learning that they could not actually control the forces that they had let loose. (See, Meltzer, History of Federal Reserve, v. 2 Part VI, "Nixon Devalues the Dollar" (1969-1973).

  "Industrial production rose 6.4 percent and real GNP 4.3 percent compound average rates. Real per capita consumption increased more than 30 percent. Annualized increases in consumer prices remained below 1.5 percent until the middle of 1965. After five years of recovery, growth and low inflation, inflation reached 5.5 percent in 1969. The Great Inflation was under way, sustained by rapid money growth to finance the government budget and pay for the Great Society and the war in Vietnam."

  Meltzer puts the Keynesians in the center of this story.

  "The years 1961-71 were a part of the Keynesian interlude dominated by a strong belief that government was responsible for stabilizing an unruly private sector. The distinguishing characteristics were two related beliefs: (1) that policymakers could adjust their actions in a timely way to smooth fluctuations and achieve full employment with high growth and low inflation, and (2) that policymakers could choose and achieve the right, possibly optimal, combination of inflation and full employment. Keynesian economists called their program 'the new economics' to signify the departure from prevailing orthodoxies. They did not concern themselves with the way their prescriptions would work in a political system." 

  Actually, it was gold - the much maligned "barbaric metal" - that extended the period of apparent success so long. Meltzer notes that it was gold that "tied down expected inflation" to tolerable levels until so much gold had been expended that the end had become apparent.

  "In office, the new administration made a determined effort to apply Keynesian economic policies including the relatively new Phillips curve, relating inflation and unemployment. As understood at the time, the Phillips curve implied incorrectly that policy could permanently reduce unemployment by increasing inflation. Instead of aiming for price stability, the government would choose where to set the tradeoff."

  William M. Martin, Jr., was the chairman of the Board of Governors (the "Board") of the Federal Reserve System (the "System"). He was a registered and loyal Democrat and quickly affirmed his willingness to cooperate with the new Democratic administration. Alfred Hayes was president of the N.Y. Federal Reserve Bank (the "N.Y. Fed"). Robert Rouse was the manager of the System account at the N.Y. trading desk.
 &

  The Keynesians wanted looser monetary policy, budget deficits and lower interest rates to deal with the stubbornly high level of unemployment and provide faster rates of economic growth. Tax reduction policies were the fastest way to get the ball rolling. The "bills only" constraint on System open market operations was removed to increase monetary policy flexibility. The role of the federal government ballooned and the size of national budgets and budget deficits doubled in nominal terms as the Kennedy/Johnson administration initiated the welfare state and the war in Vietnam.
 &
  Kennedy was skeptical of the new economics, but Johnson entertained no doubts. Johnson (in typical liberal style) was in intentional denial of financial constraints. He determinedly plunged ahead, leading the nation into the financial and military morass. Since the dollar was the world's primary reserve currency, the inflation was worldwide.

    Meltzer notes the decline in productivity growth during the decade and attributes much of the nation's financial and monetary problems to that cause. However, productivity always takes a hit during inflationary periods. It is just one of the many noxious impacts of chronic price inflation. See, "Understanding Inflation."

The experiment with Keynesian policies was crumbling, leaving behind a legacy of intractable unemployment, price inflation, business cycle volatility, national financial weakness, and a 40% increase in the federal debt.

  Free reserves and nominal interest rates were still being relied upon as guides to monetary policy. See, Meltzer, History of Federal Reserve, Part IV, "Conflicting Objectives (1951-1960)." Free reserves are bank reserves in excess of both reserve level requirements and member bank borrowing from the System. The federal funds rate was permitted to increase sufficiently to remain above the price inflation rate, but the spread between the two narrowed between 1966 and 1968 because of the surge in price inflation. The economy went into recession at the end of 1969 before price inflation could be brought under control, so the System Federal Open Market Committee (the "FOMC") quickly drove the federal funds rate down and the cycle was repeated from a higher base of inflation.
 &
  Unemployment was reduced well below 4%, but this proved to be unsustainable. Price inflation began rising in 1966 and within two years so did unemployment rates. Gold reserves were running out, with France drawing about half of the flow. France had little faith in paper reserve currencies after its experience in the early 1930s. The experiment with Keynesian policies was crumbling, leaving behind a legacy of intractable unemployment, price inflation, business cycle volatility, national financial weakness, and a 40% increase in the federal debt.
 &
  The percentage of the federal debt that the System had to monetize to keep interest rates down had increased from less than 10% to more than 15%. The percentage of the federal debt held by foreigners had increased from about 3% in 1960 to over 12% in 1971.
 &

  Bretton Woods agreement obligations were abandoned on August 15, 1971. Bretton Woods had actually been defunct since March 1968 when the U.S. began limiting gold sales to transactions between central banks. Keynesian full employment experiments both domestic and abroad rendered Bretton Woods as unsustainable as the full employment policies themselves.

  "The United States would not deflate and, with modest exceptions, surplus countries would not revalue. France favored devaluing the dollar by increasing the gold price, but the United States preferred revaluation by other countries. With memories of the 1930s in the minds of political leaders at home and abroad, no one in authority urged deflation."

  Inflationary expectations began developing in 1965, reflected in substantial increases in the all-important long term bond rate. Treasury rates rose from about 4% to almost 8%. Consumer price inflation increased from 2% in 1966 to almost 6% in 1970. President Johnson met the problems with stopgaps - but stopgaps were no longer sufficient by the time of the Nixon administration.
 &

Politically administered economic alternatives to business cycle market mechanisms proved rigid to the point of paralysis as the crises of the 1970s hurtled upon the economic world.

  The lack of an adjustment mechanism was again the problem as it was in the 1920s. Prior to the trade war in the 1920s, the gold standard had forced needed price adjustments through the business cycle mechanism. (See, Friedman & Schwartz, Monetary History of U.S, Part I, "Greenbacks and Gold," at segment on "The adjustment process of the gold standard.") However, the Bretton Woods dollar-gold exchange standard did not force required adjustments. No nation was willing to accept the business cycle adjustment mechanism, so they generated inflation and an even more volatile and vicious business cycle instead. Politically administered economic alternatives to business cycle market mechanisms proved rigid to the point of paralysis as the crises of the 1970s hurtled upon the economic world.

  "In practice, United States policymakers put domestic concerns ahead of international obligations. They told foreign governments and central banks that they should revalue their currencies. Foreigners, in turn, urged the United States to stop the flow of dollars that caused 'imported inflation.' This dialogue, sometimes called the 'dialogue of the deaf,' continued sporadically until the Bretton Woods system ended in 1971."

Keynesian policies:

"[Keynesians] proposed activist, discretionary policies aimed not just at smoothing business cycles but at fostering economic growth. With growth would come resources for reducing poverty, improving health care and education, expanding social programs, and redistributing income."

&

  The "new economics" was a theory of economic policy promoted by disciples of John Maynard Keynes.

  "The 'new economics,' as it was called, differed markedly from earlier approaches. It proposed activist, discretionary policies aimed not just at smoothing business cycles but at fostering economic growth. With growth would come resources for reducing poverty, improving health care and education, expanding social programs, and redistributing income. President Kennedy's advisers persuaded him to reduce tax rates in part by explaining that he would eventually have more revenues to finance increased spending."

  Rationalization is not reason. Keynesian concepts run counter to 2500 years of economic and monetary history. It should surprise nobody that reality conforms to expectations derived from that history rather than to the expectations of the Keynesians. See two articles beginning with Keynes, The General Theory, Part I, "Elements of the General Theory."

The federal budget was viewed as responsible for the business cycle, and was considered a drag on the economy until deficits reached levels sufficient to stimulate full employment, interpreted as no more than 4% unemployment.

  Business cycle analysts had been attempting to isolate statistical regularities. This "depended on stability of often tenuous bivariate associations eschewing attempts to relate the associations to economic theory."

  Unfortunately, every time government finds and attempts to base policy on such associations, the associations tend to disappear. The Phillips curve is perhaps the most notorious of them. The regularity of housing prices in the U.S. is the most recent. The related government policies practically guarantee that the associations on which they are based will break down. Such policy efforts continue despite the frequent frustrations.

  The 1962 Economic Report of the President produced by the Council of Economic Advisers under Walter Heller set forth the Keynesian approach. The federal budget was viewed as responsible for the business cycle, and was considered a drag on the economy until deficits reached levels sufficient to stimulate full employment, interpreted as no more than 4% unemployment. As full employment was reached, revenue would increase and real budget surpluses could pay down the deficits.
 &
  Thus, with typical left wing semantics legerdemain, budget surpluses became bad as long as unemployment levels were above the full employment level, and even deficits would be considered "full employment surpluses" and thus not sufficiently in deficit as long as full employment had not been reached. The concept of the "full employment budget surplus" attempted to provide a numerical measure of a budget deficit's restrictive or stimulatory impact on the economy.

  It was a rationalization worthy of a pyramid scheme, only it was playing with the financial health of the entire nation - and in the midst of the cold war struggle.

  The report relied on experience in the 1958-1960 period, ignoring the other 2500 years of economic and monetary history. The Keynesians in the Council of Economic Advisers did not deign to recognize the importance of gold in stabilizing the purchasing power of the dollar. Eisenhower's massive $12.8 billion 1959 peacetime budget deficit was clearly not enough since unemployment remained above 4%. Deficits should always be increased  to reduce "fiscal drag on the economy" until full employment is reached.
 &

The need to coordinate with administration policy diminished System independence even as System responsibilities were being increased to massive - indeed, impossible - proportions.

  The primary roles of the Treasury and the System were to be exchanged. According to the report, the Treasury and its budget would be primarily concerned with domestic economic objectives which the System would continue to support, but the System would now have the additional task of dealing with balance of international payments problems. The Treasury could thus conveniently ignore international payments deficit as a constraint on its spending schemes.
 &
  This additional System objective conflicted with the System's already conflicting objectives. The need to coordinate with administration policy diminished System independence even as System responsibilities were being increased to massive - indeed, impossible - proportions.
 &
  Heller would later deny that he and his report ignored the connections between monetary growth and inflation, but the report nowhere makes that connection. Many Keynesians would continue in intentional denial of the connection well into the 1980s.
 &

The report nowhere explains how such control can be achieved consistent with the 4% full employment objective - and international payments control was in fact never achieved under Keynesian policies.

  Kennedy, however, was well aware of the implications of the nation's international payments deficit. The report thus recognizes that control of the payments deficit is "essential" and may constrain discretionary budgetary and monetary policies. However, the report nowhere explains how such payments deficit control can be achieved consistent with the 4% full employment objective - and international payments control was in fact never achieved under Keynesian policies.

  "The report mentioned the need to balance the goals of inflation and unemployment. It did not mention the Phillips curve by name, but the idea of a short-term tradeoff is present, as is the possibility of shifting the Phillips curve by improving the functioning of labor markets."

  Manipulation of the tax code became the favored policy instrument. The Kennedy administration attempted to fine tune the economy to improve performance by using various tax incentives. It accepted the absurd view that tolerance of low to moderate inflation could increase employment levels on a sustainable basis. Government interventions in labor and product markets were relied upon to combat price inflation. This Keynesian view disastrously dominated U.S. economic policy until 1979.
 &

Both inflation and unemployment, with only a slight lag between the two, rose together contrary to Phillips curve theory.

  Meltzer recognizes four main errors with the report.

• First, the economic statistics were too ambiguous and imprecise to provide a basis for fine tuning policy. Thus, Keynesian economists proved - and still prove - incompetent at providing economic forecasts such as are needed for such policy.
• Second, changes that were viewed as temporary and reversible proved permanent and intransigent. Tax reductions proved easier to implement than tax increases. Prices and wages did not decline during recessions once the public began to expect a rapid renewal of inflationary policies.
• Third, the unpopularity of price inflation caught the Keynesians by surprise. Since unemployment was also unpopular, political influences whipsawed economic policy erratically back and forth. Special interests swamped government policy with new claims for benefits from the Treasury or support from government credits. Attempting to achieve too many objectives that were generally inconsistent would achieve nothing. Both inflation and unemployment, with only a slight lag between the two, rose together contrary to Phillips curve theory.
• Fourth, and "perhaps the most serious failure," economists and economic policy were incapable of establishing and maintaining some optimal mix of inflation and employment. (They could not "obsolete the business cycle.") The public responded to current stimulatory actions but quickly came to ignore promises and solemn commitments to restore budget surpluses and monetary discipline.

Monetary policy under William M. Martin:

  Monetary policy dealt with price levels, interest rates, economic output and the balance of international payments. Too much emphasis on any one of these factors would unbalance the others and ultimately undermine even the primary objective.
 &

Monetary policy was tied as a practical matter to congressional and administration policies that could for political reasons undermine any and all of the monetary policy objectives. There was no consensus - and often no understanding - of what monetary policy did or how it worked.

  Moreover, there were other players in the game - Congress, the administration, and private financial and industrial entities - and foreign influences - that could and did play determinative roles. Further, the statistical indicators and tools of monetary policy were imprecise and tardy. Even worse, monetary policy was tied as a practical matter to congressional and administration policies that could for political reasons undermine any and all of the monetary policy objectives. There was no consensus - and often no understanding - of what monetary policy did or how it worked.

  "Even the best judgment could not achieve any precise goal because many other factors affected prices, output, balance of payments and interest rates. The most one could do was to do one's best and hope that others would do the same."

  Thus, Martin was well aware that monetary policy could exercise powerful but never controlling influence. He was cautious and tentative.
 &

"{Monetary] policy gave greatest weight to unemployment, reinforcing the tendencies brought by the Employment Act."

  The System became dominated by political influences, exactly as its founders feared and had tried to prevent. Martin was drawn into coordination with administration policy. Martin limited his "independence" to his ability to have frequent sessions with the president and his economic advisers where Martin could explain the monetary concerns of the System. These concerns were generally ignored by the administration until the end of the Kennedy/Johnson years. Martin was also free to choose monetary policy tactics, as long as they were directed at achieving administration objectives. The System was "independent within the government," not independent from the government.

  "By coordinating policy, Martin partly subordinated the Federal Reserve's concerns to the administration's. A principal result was that policy gave greatest weight to unemployment, reinforcing the tendencies brought by the Employment Act. But Martin continued to express concern about inflation and warned President Kennedy as early as the second quarter 1961."

There was no evidence of recognition that full employment and other policy objectives were impossible without control of price inflation and resolution of balance of payments problems.

  The System's main criticism of Keynesian views was that unemployment was caused by structural problems requiring flexible market responses. The System also had greater concerns over price inflation and the balance of international payments, both of which were negatively impacted by Keynesian demand stimulus policies.

  The Keynesians determinedly and stubbornly rejected these concerns until they were hit over the head by the proverbial two-by-four of reality.

  Milton Friedman was one of the most prominent critics of Keynesian views. His criticism is summarized by Meltzer.
 &
  Extensive reviews of monetary and fiscal policy were completed in the 1961-1962 period. There was a Commission on Money and Credit initiated by the Eisenhower administration, a System staff response, and a Keynesian report by the Kennedy administration Council of Economic Advisers. Meltzer summarizes them and the disagreements among them.
 &
  The bottom line is that the government was increasingly undertaking to manage the economy based on various rationalizations that had little or no basis in reality. Everyone agreed that the dollar and the balance of payments problems were important but should be subordinated to domestic full employment policies. There was no evidence of recognition that full employment and other policy objectives were impossible without control of price inflation and resolution of balance of payments problems.
 &
  The Eisenhower Commission emphasized interest rates but divided between Keynesian emphasis on demand stimulus policies and emphasis on fundamental market structures like labor market rigidities and minimum wages. The Kennedy Council was Keynesian. Both the Commission and the Council expressed Keynesian optimism about the ability of government management to stimulate high sustained levels of economic growth well above the historic average.
 &
  The System staff response reflected several modifications of previous views. It especially rejected financial controls. It reemphasized discount rate policy although still relying primarily on open market operations which were executed through the N.Y. Fed trading desk, and still viewed the level of discounting as a constraining factor instead of as frequently a reflection of stimulative credit conditions. It still rejected any primary responsibility for the balance of payments or other international concerns.
 &

1960-1961 recession:

  The 1960-1961 recession was short and shallow. Although unemployment hit 7%, it was rising from an already high base.
 &

  The Keynesians blamed the Eisenhower 1960 budget surplus. An Eisenhower official blamed the end of a major labor strike in the steel industry. Meltzer blames a decline in the real value of the monetary base. The "monetary base" frequently referred to by Meltzer includes currency and bank reserves. The "money stock" frequently referred to by Milton Friedman includes currency and demand deposits, and is thus generally a broader measure than monetary base. In nominal terms, the monetary base had no growth in the spring and summer of 1960 while real interest rates were surging higher.
 &
  This Eisenhower period experienced "the only sustained deflationary action during the Bretton Woods  years." The System reduced the discount rate twice, but was torn between domestic growth and stopping the gold outflow. The manager of the System account at the N.Y. trading desk received only vague directions from the Federal Open Market Committee (the "FOMC"), and the System achieved neither objective.
 &
  However, price inflation was subdued and free reserves were increased by about $1 billion as desired. The federal funds interest rate dropped below 2% by the end of 1960. The Treasury bill rate remained between 2.2% and 2.5% until December, well above the lows of the previous two recessions. Concern over the gold outflow was for the first time a constraint on domestic monetary policy.
 &
  The decline in money growth was noted but no action was taken. Several FOMC members were now in favor of using monetary aggregates as policy targets. Martin expressly delayed further action until after the election to avoid partisanship - but this inevitably favored the partisan interests of the Democrats.
 &

The FOMC directives were so general in nature that Robert Rouse, the manager of the System account in New York, was in effect running monetary policy according to his own judgment.

  Both unemployment and the gold outflow were surging by October 1960. Dealing with one had to negatively impact the other. The Eisenhower budget surplus had reduced the number of Treasury bills to a point where the market had too few for monetary policy manipulation. Longer term securities were used instead, and "bills only" policy was on its last legs.
 &
  The manager was now directed to take international developments into consideration, but nobody knew how this could be done without undermining his other directions, so he ignored this part of the directive. Nevertheless, as the months passed, it was clear that the international payments and gold outflow problems were in fact constraining how stimulatory the FOMC was prepared to be. At least price inflation, now well below 2%, was not an obstacle to policy. By the end of the year, the real base money stock had at last turned positive. However, $1.2 billion in gold had flowed out in that final quarter of 1960.
 &
  Meltzer tells of a clear desire to stimulate economic recovery but considerable disagreement about how that could be done while gold was hemorrhaging out through the Swiss and London gold markets. The FOMC directives were so general in nature that Robert Rouse, the manager of the System account in New York, was in effect running monetary policy according to his own judgment.
 &
  The recession ended in the first quarter of 1961. It was actually one of the shortest and mildest in System history. Confidence was restored at home and abroad, reflected in domestic economic recovery and a substantial reduction in the gold outflow.
 &

  The System was still "groping" for a suitable monetary policy to assure continued economic growth without inflation as the Kennedy/Johnson administration got underway in 1961. "The usual uncertainty under which monetary policy operated" continued throughout the 1961-1965 period. Uncertainty frequently resulted in no action to change the directive to the System account manager. Kennedy's Cold War military buildup expanded budget deficits.
 &

  The manager of the System account was now considering as indicators short term interest rates, member bank borrowing from the System and the cost of dealer financing. He continued to evaluate "the color, tone and feel" of the money markets and the distribution of reserves between New York and Chicago and the other regions. Total reserves as well as free reserves were also considered.
 &
  The FOMC was generally divided as to what should be done. Worry over the balance of payments and future inflation caused some to counsel monetary tightening, but periods of slow growth caused others to counsel monetary ease. Outcomes often differed substantially from FOMC member intentions. Martin ended each meeting with a statement of the meeting consensus that mentioned the ambiguities, "perhaps because  he preferred managerial discretion or doubted that the FOMC could agree on a specific target or improve performance by setting and enforcing a more precise target."

  "Ambiguities in the discussion and the directive and failure to define terms like "ease," "restraint," and "no change" also gave considerable discretion to the manager. Nevertheless, changes in free reserves remained broadly consistent with the FOMC's intent, and bill rates remained in a narrow range."

 Meltzer provides many pages of detail about the conflicting, shifting, uncertain views of the FOMC members as they grappled with a vast complex constantly changing system that nobody really understood. However, the approaching 1964 presidential election was all too clear, and pressure grew for more rapid economic growth. By the end of 1962, economic growth had indeed picked up, but the money stock was rising at a 6% annual rate.
 &

Keynesians take charge:

&

  Heller and other administration Keynesians were anxious to experiment with flattening the yield curve - bringing long term interest rates down to stimulate the economy while short term rates were permitted to rise to deal with the international payments problem.
 &

  This policy "twist" called for the System to buy longer term securities, so the "bills only" policy was dead. Martin signed on as a loyal administration soldier, further undermining System independence. Rouse, the manager, believed that the new policy could be effective, but there was considerable skepticism within the FOMC. The experiment had already been tried in the 1930s with little result.
 &
  Immediate efforts were a success as long term rates declined while short term rates rose, flattening somewhat the yield curve. Subsequent academic evaluation of the policy, however, concluded that "even sizable changes in the term structure of debt exert only a relatively small and short-lived impact on the shape of the yield curve."
 &
  Heller blamed Martin and the System for a half-hearted start-and-stop effort that failed to sustain the impact. However, a sustained effort would amount to an effort to peg long term rates, something Martin opposed. 
 &
  Meltzer reviews System data running through 1964 that indicates that Martin's commitment to the program was indeed lukewarm at most. After six months and billions of dollars in transactions, long term rates were unchanged and bill rates were actually a bit lower than at the beginning. The yield curve was actually a bit steeper.
 &
  Private investors were abandoning the long term markets whenever the System reduced their yield, exactly as traditional economic theory would have predicted. Opposition to the program increased within the FOMC. Martin feared that the System was becoming the predominant purchaser of long term Treasuries - implementing a classic monetization of debt. While the gold outflow had materially declined, it persisted. The main impact of Martin's commitment to an easy money policy was a federal funds rate as low as 1.16% a half year after the beginning of the economic recovery.
 &

  There was increasing displeasure with FOMC monetary policy and its directives and especially with its use of free reserves as its policy target. Meltzer summarizes the conflicts. Interest rate, total reserves and monetary aggregate targets were increasingly favored, but there was no agreement within the FOMC so there was no change. Martin remained opposed to providing Congress with any hint that the System could or would control interest rates as that must inevitably lead to the blatant monetization of federal debt.
 &
  The FOMC still could not agree on any precise policy target or even any precise policy. It was now divided between those with Keynesian views and those who rejected them.

  "Instructions to maintain the tone and feel of the market, achieve moderate ease, or err on the side of restraint gave little direction even when the members agreed on the action to be taken. When they differed, as in 1960-61, the manager's discretion increased. Often the instructions in the directive and the stated consensus were so imprecise that one member would criticize the manager's actions as inconsistent with his instructions. Another would follow with praise for the manager's performance. Unable to agree on its objective or how to reach them, the FOMC continued to offer little direction.

  Monetary policy was reacting to immediate market fluctuations with little knowledge about what was transitory and what was permanent or how immediate policy actions contributed to meeting long term objectives. Martin was properly dubious about the broader economic theories and economic models of that time. At least the imprecise directives covered up the lack of agreement within the FOMC and permitted an appearance of consensus - an important public relations objective.

  "This grant of discretion pleased the manager and the New York administration. They could now operate as they did before bills-only."

  Ambiguity permitted Martin, Hayes and Rouse to change directions between FOMC meetings if they thought conditions warranted.
 &

  Procedural changes were made for the directive at the December 1961 FOMC meeting. Political influences permeated the discussion of the "independent" System committee. For the first time, an interest rate target was chosen, increasing the Treasury bill rate to 2.75%. A total reserves target was also included. The "bills-only" policy was formally abandoned.
 &
  Meltzer extensively covers this meeting. A great deal of effort was expended nit-picking precise verbiage for public relations and political purposes.

  "There was not enough agreement about what the committee intended the directive to do and how it was supposed to resolve contentious issues. The committee revisited these topics several times, using experience with the changes they made to guide additional changes."
 &
  "Before long, the directives were as vague as before. The members did not agree on the way to measure policy, so they could not write a precise directive. Martin showed no interest in pushing for more precision or clarity, perhaps because he did not favor it, perhaps because agreement was unlikely, perhaps both."

  Half the Reserve Bank presidents retired during the first two years of the Kennedy/Johnson administration, greatly changing the policy thrust at the FOMC. However, Heller and the other administration Keynesians did not get the Board appointments that they wanted. Robert Rouse and Woodlief Thomas left the staff in 1967. 
 &
  Martin succeeded in reversing the appointment procedure for the new manager. The FOMC would make the appointment subject to N.Y. Fed approval. Hayes, as a member of the FOMC, played a role in the appointment, and Robert W. Stone, an assistant vice president of the N.Y. Fed, was chosen. He would be succeeded by Hugh Galusha soon after Lyndon Johnson's election later in the decade.

  "All succeeding managers to date have come from the New York bank. New York remains the only place to gain experience in operating the desk, as several members recognized at the time."

Gold:

  The flow of gold abroad did have some balancing impact just as gold standard theory would have expected.
 &

  The gold flow pushed up price inflation abroad at higher rates than in the U.S. This reduced pressure on the dollar until the middle of the 1960s. In addition, West Germany made early payments of $2.3 billion of its debt to the U.S. and, with the Netherlands, revalued by a modest 5%. Kennedy pledged to maintain the $35 gold price. Along with the strengthening U.S. economy, this temporarily reversed the gold outflow and provided the Kennedy/Johnson administration some early running room for its Keynesian policy experiments. However, U.S. gold reserves declined below U.S. foreign liabilities in 1961.
 &
  The System geared up to play a bigger role in the nation's balance of payments and gold outflow problems. Charles A. Coombs, from the N.Y. Fed, was chosen to fill the new position of Special Manager for the Foreign Currency Open Market Account. The N.Y. Fed was back in business, negotiating with foreign central banks over exchange rate problems. Arrangements were made for coordination and cooperation with the Treasury. These arrangements fell into disuse when the dollar strengthened in the 1980s and were allowed to lapse in 1998.
 &
  The gold outflow even at modest rates reached significant proportions over time. In the first two years of the Kennedy/Johnson administration, the decline was 10%, leaving gold reserves at a new total of about $16 billion. Gold reserves at five major European countries and Japan increased in similar amounts, although this increase included supplies from other nations and new production.
 &
  In the dozen years to 1970, U.S. gold reserves were cut in half to just over $11 billion. Reserves at the six major accumulating nations rose in an amount equal to about 70% of the U.S. outflow. France, always suspicious of foreign paper currencies, took about a quarter of this amount. Germany and Japan, although major export surplus nations, held most of their reserve balances in dollar denominated securities. Canada and Great Britain had significant gold outflows during this period.
 &

Each nation faced political constraints on their exchange rate policy, and acted as if there were no political constraints on the exchange rate policy options of other nations.

  The exchange rate adjustment problem had not changed since the 1920s and was still unresolved. It remained unresolved throughout the 1960s. Each nation faced political constraints on their exchange rate policy, and acted as if there were no political constraints on the exchange rate policy options of other nations.

  "As in the 1920s, countries' willingness to coordinate or cooperate did not include deliberate policy changes to produce inflation in surplus countries or deflation in deficit countries. Under the fixed exchange rate system, foreign governments had little choice. Unwilling to appreciate their currency or devalue the dollar, they complained about imported inflation but could not prevent it. Deflation in deficit countries was a common fear."

  Martin understood the constraints on any monetary policy response.

   "[The] political system would not tolerate the deflation necessary to reduce the cost of exported goods, and increase the relative price of imported goods, to pay for foreign transfers and loans at an unchanged nominal exchange rate."

  Meltzer goes at some length into the administered alternative arrangements for dealing with balance of payments and exchange rate problems. Open market transactions, currency swap arrangements, funding for a Treasury Exchange Stabilization Fund, a "gold pool" that unified the transactions of the major central banks in the London gold market - these arrangements grew to involve tens of billions of dollars and increased in sophistication, but could do no more than manage the continuing deterioration of the nation's finances and provide temporary support for an illusion of ability to resolve the problem.
 &

  Martin was completely candid with Congress and the public. He repeatedly explained that these efforts were mere stopgaps to buy time for Congress to deal with the fundamental causes of the problem. However, Congress and the administration were now dominated by Keynesian concepts and were politically paralyzed. They could do nothing.

  "There are many statements recognizing that currency market intervention could not reduce the payments imbalance. At various times, Martin and his colleagues cited increased productivity, reduced government spending abroad, foreign aid, military assistance, and other real factors as the principal causes of the problem or the sources of potential improvements. And they recognized that currency market intervention was just another type of open market operation. The only advantage was that the swap arrangement delayed a reduction in the gold stock and reduced dollars held by foreigners. The offset was an obligation to repay the borrowed foreign currency in ninety days, with one possible renewal -- later extended --. It differed mainly because it gave a temporary stay to gold sales."

  Central bank cooperative efforts, Meltzer emphasizes, were not an adequate substitute for exchange rate market adjustment mechanisms either in the 1920s or 1960s.

  "[In] both periods, the main weakness in the exchange rate system arose because any central bank holding a large stock of dollars could precipitate a crisis by demanding gold. The rule provided no means to adjust to such an attack."

There were only two alternatives - either austerity and deflation or revaluation of gold and devaluation of the dollar in gold terms. Both were politically untenable, so government policy was paralyzed.

In 1962, inflation was greater among the nation's major trading partners abroad than in the U.S. The trade surplus and current account surplus expanded significantly until 1964.

  Inflationary domestic policies inherently undermine the dollar. Keynesian rationalizations could not change this unalterable reality. This left only two alternatives - either austerity and deflation or revaluation of gold and devaluation of the dollar in gold terms. Both were politically untenable, so government policy was paralyzed. Meltzer summarizes the intellectual debate over fixed and floating exchange rates and alternative adjustment mechanisms.
 &
  The international payments deficits were initially met with a variety of stopgaps that had sometimes minor or temporary benefit. Foreign governments, especially Germany, accelerated payments on their debts to the U.S. and on their contracts for defense material, and the Treasury sold "Roosa bonds" denominated in foreign currencies. Exports were promoted, foreign aid was tied to exports, and military spending abroad was reduced. The IMF was beefed up. Taxes were imposed on capital outflows.
 &
  However, the spending proclivities of Congress were unstoppable. The budget deficit grew in 1963, the trade surplus began to decline in 1964, and foreign liabilities exploded upwards in 1967. Meltzer asserts that, by this time, Vietnam war expenditures were the primary villain. He points out that in 1962, inflation was greater among the nation's major trading partners abroad than in the U.S., and that the trade surplus and current account surplus expanded significantly until 1964. Without Vietnam, that might have ended the payments deficit. Several other measures of U.S. competitiveness started moving against the dollar in 1965 and 1966.
 &
  Friedman was the leader of those arguing the inevitability of floating the dollar exchange rate.

  The publisher of FUTURECASTS online magazine published "Dollar Devaluation" in 1967, forecasting not only the abandonment of fixed exchange rates but also explaining the inflationary consequences that would follow. The real problem was the inevitable failure of Keynesian economic policies.

  Most European governments were running mercantilist policies, Meltzer points out. Their criticism of the U.S. did not acknowledge their own policy failings or that a more austere U.S. policy that contracted its economy and stabilized its international payments would cripple their export-driven economies. Nor were they meeting their share of NATO  defense obligations. The whole international system was afflicted by the anti-market (frequently socialist) policies of its governments.
 &

Regulation Q: 

 Ceilings under Regulation Q on interest rates paid on time deposits and the difficulties and unintended consequences they caused are summarized by Meltzer.
 &

  As market interest rates rose, they put pressure on Reg. Q ceilings. Rates for time deposits were raised to 4% towards the end of 1962. Nevertheless, efforts at circumvention proliferated. Money flowed abroad into the eurodollar market seeking higher rates of return and worsening the nation's balance of international payments deficit. It was the poor and the poorly informed who bore much of the cost.

  "Regulation could restrict the increase, but it could not keep depositors from withdrawing in search of higher rates. Euro-dollars were one of the first big innovations, but others followed, including money market mutual funds, which grew rapidly in the 1970s. By the 1980s, inflation and the effect of interest rate controls on savings and time deposits penalized and to a considerable extent destroyed the savings and loan industry that regulators claimed the controls would protect."

Keynesian prosperity:

  The first term of the Kennedy/Johnson administration experienced sustained prosperity and CPI inflation limited to about 1% per year.
 &

By the end of 1965, the Great Inflation had begun, although this was still a year prior to the major surge in Vietnam war spending.

The Keynesians were apparently fulfilling their promise. Both the international payments deficit and gold outflow declined appreciably, but ominously continued.

  Despite years of solemn promises and assurances by high government officials of undoubted capacity to maintain the silver in the coinage, silver was withdrawn from the coinage and as backing for silver certificate currency - without a qualm concerning the broken assurances and promises..

  Growth of the monetary aggregates accelerated in 1963 and long term interest rates edged up into new post-WW-II highs. In 1965, the beginning of the second term, things started to go downhill. Fevered leveraging was reflected in a doubling of the rate of growth of "velocity." "The Great Inflation had begun," Meltzer states. This was still a year prior to the major surge in Vietnam war spending.
 &
  The period of Keynesian triumph lasted well into 1965. Unemployment fell to 3.6%. The flow of dollars abroad imposed higher rates of price inflation on mercantilist states because they refused to revalue their currencies to equalize the trade and payments balances. Yearly rates of price inflation between 1960 and 1962 ranged from 5.4% for Germany to 8.3% for France. and 12.5% for Japan. The U.S. during this period had only 2.5% price inflation. Clearly, Meltzer points out, real exchange rate adjustment was actually occurring despite interventionist government policies. By one measure - the official settlements calculation - the U.S. payments balance turned positive briefly early in 1964.
 &

  Interest rates rose gradually from the middle of 1963. Federal funds, discount and Reg. Q rates went up as did market rates and the Bank of England's rates. Growth of the monetary aggregates was accelerating. Meltzer stresses base money growth, rising 4% in 1963 and 6% in 1965, "presaging the inflation that soon brought the low-inflation period to an end."
 &
  The interest rate increases that started in the middle of 1963 were primarily in response to balance of payments and gold outflow problems and European criticism of U.S. failure to grapple with them. The Europeans wanted the U.S. to fix European inflation problems, since they Europeans were politically unable to take appropriate action such as currency revaluation themselves.
 &
  This was the first time since the British pound devaluation crisis in 1931 that the System discount rate was increased solely to support the exchange rate. The tentative nature of economic recovery had previously held the System back, but by that summer there no longer was any doubt about the vigor of the recovery. The discount rate was increased to 3.5% in July, 1963. Treasury bill rates spiked about ½% in anticipation as the decision was leaked.
 &

The various financial controls and other stopgaps were a pitiful confession of political futility.

  The markets by now were moving efficiently against all the stopgap measures. The discount rate increase had little apparent impact on international flows or on the economy. The 25% gold reserve for Federal Reserve notes was doomed. The monetary aggregates were rising at an accelerating rate as is inevitable with long term commitment to Keynesian policies. The various financial controls and other stopgaps were a pitiful confession of political futility.

  "At most controls and restrictions may have given the United States more time to adopt a permanent program. The Kennedy, Johnson, and Nixon administrations never developed policies to sustain the Bretton Woods system. This left the solution to monetary policy, controls, and the market. As prices rose abroad relative to domestic prices, the current balance improved. Foreign governments did not like 'imported inflation,' but they disliked currency revaluation or slower growth of the U.S. economy even more. Abroad, as at  home, maintaining employment and preventing recession had higher priority."

  During the first half of the 1960s, deposit insurance was increased to $15,000, authorization for mortgage loans by national banks was increased to 80% of market value, and there was broad regulatory liberalization for banks and corporations operating abroad. The futility of price and wage guidelines, guideposts and controls began to be starkly demonstrated - but was still determinedly ignored by proponents.
 &

President Lyndon B. Johnson:

  Lyndon Johnson became president in November, 1963 upon the assassination of President Kennedy.  He could not have asked for a more favorable economic situation.
 &

Johnson inherited the Kennedy administration and its Keynesians.

  He inherited a thriving economy and an international payments situation that was practically in balance. Price inflation in the major nations abroad was significantly greater than in the U.S. The U.S. gold stock had not declined for 18 weeks. However, he also inherited the Kennedy administration and its Keynesians.
 &
  Heller quickly convinced Johnson to push for the Kennedy tax cut initiative to assure continued economic expansion. Johnson did not have to be reminded that 1964 was a presidential election year. Where Kennedy was suitably skeptical of Keynesian assertions, Johnson was an immediate and enthusiastic believer. Johnson didn't want economic reality to constrain his Great Society spending schemes or Vietnam war plans. Heller's influence increased enormously.
 &

  Keynesians also dominated the System by this time. Despite continued anti-inflation rhetoric, monetary policy responded primarily to unemployment concerns. Unfortunately, inflation ultimately causes unemployment - something Keynesians remained (stupidly) in denial about.
 &
 There was rapid expansion in leveraging throughout the economy reflecting increased business confidence. System gold reserves were periodically dropping close to the 25% minimums at individual Regional Reserve Banks. Much of the improvement in international payments and gold flows was clearly due to temporary factors. Abroad, interest rates were rising.
 &
  Johnson announced his war on poverty program in 1964. The 25% gold reserve requirement against Regional Reserve Bank reserves was removed by Congress in 1965. Congress would remove the gold reserve requirement entirely three years later. The nation thus moved a major step closer to the totally fiat monetary system that would accommodate the Keynesian policies that led to the inflationary morass of the 1970s.
 &

  Already, under the surface, System monetary policy had resulted in a 6% rate of increase in the money stock. The manager of the System account abandoned free reserves as a target and shifted to the federal funds interest rate. Martin strongly opposed this shift. He still did not want direct control of interest rates that would expose the System to direct Congressional pressure to maintain artificially low interest rates. Free reserves thus remained a target in FOMC directives. The problems of the directive had not been solved.

  "One was the problem of knowledge. What should the FOMC know to carry out its mandate? What could it know? How important was consensus? Was it better to use vague statements that everyone could accept or to be more precise and report differences of opinion? Underlying much of the discussion was the relative weight attached to public relations and operating instructions to guide the manager."

Uncertainty concerning the beginnings and ends of trends, the inability to distinguish temporary from permanent changes, the inaccuracy of initial statistics, and uncertainty as to the extent and duration of the impacts of monetary policy actions were all recognized as limitations on monetary policy capabilities.

  There was as yet no knowledge of the precise linkages between monetary policy actions and objectives. The objectives themselves were often vague and were actually inherently inconsistent. Some FOMC members put greater emphasis on eliminating unemployment, others on international payments. There were frequent disagreements within the FOMC as to the economic outlook. Uncertainty concerning the beginnings and ends of trends, the inability to distinguish temporary from permanent changes, the inaccuracy of initial statistics, and uncertainty as to the extent and duration of the impacts of monetary policy actions were all recognized as limitations on monetary policy capabilities.
 &
  There was wide disagreement on appropriate policy targets and indicators. Division and uncertainty within the FOMC resulted in vague and tentative directives that in effect left monetary policy largely in the hands of the manager of the System account. Frequently, the System was behind the power curve - following market interest rates rather than setting them.
 &
  The manager had to be concerned both with immediate market stability and longer term objectives. Developing precise directives would have shifted responsibility from the account manager at the N.Y. Fed trading desk to the FOMC staff in Washington, with an increase in rigidity and a decrease in experience. The manager's focus was always on immediate money market technical details like the three month bill rate, the federal funds rate, the dealer loan rate. He had his hands full just maintaining money market stability. Longer range objectives such as inflation or unemployment levels just didn't register. Transitory movements that affected interest rates held his attention.
 &

  The System provided faster monetary growth. Even as economic growth accelerated, the federal funds rate remained around 3.5%. After a short period in the black during the first quarter or 1964, the international payments deficit resumed. While price inflation remained subdued, major unions were breaching wage guidelines.
 &
  Johnson was elected in a landslide. Gardner Ackley, another Keynesian, replaced Heller as chairman of the Council of Economic Advisers. He was full of the Keynesian conceit and denigrated concerns about inflation.
 &
  Abroad, the pound came under pressure. Interest rate increases at the Bank of England induced a half point increase to 4% in the System's discount rate and to 4.5% in the Reg. Q interest rate ceiling for time deposits. Many at the FOMC viewed the pound crisis as a good excuse for the tightening that they thought was needed for domestic reasons. Ackley responded to the rate increase with alarm and advised further stimulatory tax reductions.
 &
  Congress passed excise tax reductions for autos and air conditioners effective May, 1965. The Johnson administration pressed the pedal to the metal with massive spending increases and budget deficits for his Great Society initiatives. By the end of 1965, the government had to pay significantly higher rates of interest on its bonds.
 &

  However, the escalation of the Vietnam war was the major factor. Johnson hoarded his political capital for his domestic Great Society concerns. He prevaricated about his military intentions during his election campaign, hid its costs as much as possible, and refused to impose the taxes needed to fund it. The long term consequences were dire. His estimates for his war costs were about $16 billion short for fiscal 1967.
 &
  Martin came under immediate pressure to peg interest rates, but it was not until the end of 1967 that the monetary aggregates surged higher.

  "Martin knew that the budget estimates understated the increase in defense spending and that Johnson had suppressed the planned increase. He knew also that contrary to standard practice, the Budget Bureau would not discuss the budgetary projections with him or his staff. Martin distrusted President Johnson and was inclined to give more attention to markets than to economists' forecasts. Government bond yields began to rise in August and had increased twenty basis points by mid-November to the highest level since 1960. This was a large increase by the standards of the time."

The country would not tolerate the austerity and unemployment needed to stop inflation once it got started. Despite their assurances to the contrary, Keynesians had no capacity to control inflation.

  Keynesians generated disingenuous rationalizations to obscure the obvious responsibility of budgetary and monetary policies for price inflation. Temporary factors were highlighted. Insane "cost-push" theories were favorites. Events in the 1980s and 1990s, Meltzer points out, decisively punctured "cost-push inflation" concepts. In the absence of monetary inflation, such factors could not have any persistent impact.
 &
  Persistent price inflation forced widespread recognition of the truth. The country would not tolerate the austerity and unemployment needed to stop inflation once it got started. Despite their assurances to the contrary, Keynesians had no capacity to control inflation.
 &

  The System increased both the discount rate and Reg. Q by another half point in December, 1965. Martin trusted the opinions of experienced market professionals, not academic Keynesian theorists. The professionals saw that the large increase in lending to support war production would dominate immediate credit market prospects. The System was responding to the expansive pressure in the financial system but it was obviously behind the power curve. The 4.5% discount rate was the highest since 1929. (Keynesian efforts to push interest rates down ALWAYS ultimately cause higher interest rates.)
 &
   Now, Martin had to face fire from both the administration and the usual suspects in Congress - Senators Paul Douglas (D. Ill.), Jacob Javits (D. N.Y.) and William Proxmire (D. Wis.) and Martin's primary nemesis, Congressman Wright Patman (D. Fla.). However, later that same month, the Budget Bureau and Council of Economic Advisers announced new budget numbers that justified the System rate increases. The figures also justified inflation concerns and a tax surcharge proposal. Even so, Johnson and Congress could not be convinced to act on the tax proposal until 1967.
 &
  The System was indeed behind the inflation power curve, as was the tax increase. The monetary base and M1 aggregate grew at an accelerating rate as the System strove to limit market interest rate increases by monetizing increasing amounts of federal debt.
 &

  Total member bank reserves grew at a 6.3% annual rate through June 1966. Treasury bonds and federal funds rates rose above the discount rate, so there was a rapid increase in member bank discounts. Price inflation hit 2.8% early in 1966 - not yet serious but no longer something that could be totally ignored. Failure to recognize the difference between nominal and inflation adjusted "real" interest rates was becoming serious.
 &
  Treasury financings became increasingly frequent as the budget deficits increased. System "even keel" coordination obligations increasingly undermined System operational independence. "Even keel" efforts to stabilize interest rates usually began one week before and lasted one week after Treasury financing operations other than for bills. However, they could be repeated in short succession over periods that sometimes lasted for many months.
 &
  The monetary effect generally was a surge in the growth of the monetary aggregates as debt was monetized to peg interest rates. The monetary surge was never unwound and so was permanent.
 &
  Paul Volcker abandoned the coordination obligation in the 1980s. He used high real interest rates and a deep recession to successfully fight inflation despite the massive budget deficits of the Reagan administration. To deal with fluctuating interest rates, the Treasury shifted to auctions for its securities instead of floating them at a set price. Reagan was willing to spend political capital to support Volcker. Johnson was no Reagan.
 &

Chronic price inflation begins:

  The basic monetary aggregate - M1 - tells the story. From a 1% growth rate in 1962 it rose through 2% in 1963, 3% in 1964, 4% in 1965 and 5% in 1968, staying about that level for the rest of the decade.
 &

Without a fixed exchange rate, price inflation would have been substantially higher substantially sooner.

Inflation clearly didn't prevent instability, unemployment and recession. After a time lag, it obviously caused instability, unemployment and recession. Only the expenditures from gold reserves delayed these impacts.

  Price inflation followed, rising from a 2.5% to 3.5% range in 1965 and 1966 to a 5% to 6% range in 1968 through 1970. The monetary base - Meltzer's favorite monetary aggregate - followed a similar pattern, except for substantial dips in 1966 and 1969 when it accurately foretold an economic slowing and a recession. The reasons were not obscure - the System had to monetize increasing amounts of government debt, flooding the financial system with additional money.

  "In 1961-64 inclusively, the Federal Reserve increased the base enough to finance 33 percent of the annual budget deficit; and 1965-71, the percentage increased to 50 percent. Despite a small budget surplus in 1969, deficits on average were substantially larger -- $8.8 compared to $5.3 billion --, and the Federal Reserve financed a higher percentage. Money growth rose as a result, and inflation followed."

  The nation's balance of international payments was an unavoidable casualty, so gold reserves had to be expended to support the purchasing power of the dollar. Without a fixed exchange rate, price inflation would have been substantially higher substantially sooner.
 &
  Another casualty was "real GNP" growth -- the inflation adjusted measure of economic growth. This plunged in 1966, recovered somewhat in 1968, and plunged again in 1969 and 1970 - this time into recession. Inflation clearly didn't prevent instability, unemployment and recession. After a time lag, it obviously caused instability, unemployment and recession. Only expenditures from gold reserves delayed these impacts.
 &
  The rate of productivity growth was another casualty. Productivity growth was impacted directly by the diversion of resources for war and redistribution, (and indirectly by the noxious unintended consequences of inflation).
 &

  Nixon's monetarist economists recognized the problem, but Nixon, who had been burned by the 1960 recession, was fixated on the predominant short term objective - the 1972 election. Arthur Burns became chairman of the System Board in 1970. He became convinced that the level of unemployment required to control inflation was politically unacceptable so inflation had to be accepted and managed through various controls and other stopgaps. This was a prescription for disaster.
 &
  1969 was the 20th anniversary of the Employment statute. This was celebrated by the Keynesians as their policies now unstoppably drove the nation deeper into the Great Inflation.

  "In short, the simple Keynesian model as applied in the late 1960s had three major flaws. It did not generally distinguish between nominal and real interest rate changes. It presumed that the government could permanently reduce the unemployment rate by permitting the inflation rate to rise. And it did not distinguish between one-time price level changes and maintained rates of price change. Each of these errors continued throughout the 1970s. Later, the political decision to keep the unemployment rate near 4 percent and to underweight the cost of inflation added to the mistakes that maintained the Great Inflation in the early 1970s."

  1966 was the sixth year of economic expansion. Unemployment was at 3.8% and industrial production rose 9.4%. Keynesians were triumphantly at the economic policy helm. However, the monetary aggregates were growing at about 6% and the first quarter price deflator was as high as 4.8%. The federal funds rate rose to 4.6%, but in real terms it was negative. The decline in free reserves was again the result of increased member bank borrowing from the System as the recently increased discount rate slipped behind market interest rates.
 &
  By March, even the Keynesians began having doubts. However, after the political heat received by the System for its last discount rate hike, the FOMC wanted further restraint to come from the budgetary side - from a tax increase or spending cuts. Johnson feared that spending cuts and tax increases would hit his Great Society programs and increase opposition to the war, so he just postured and introduced various stopgaps. He tried to fight generalized price inflation by attacking individual price increases.
 &
  The FOMC was yet again misled by its misreading of changes in free reserves and its continued failure to distinguish nominal from real interest rates - now constituting a very substantial difference. Free reserves were falling and nominal interest rates were rising, but the monetary aggregates kept growing rapidly. Much to Martin's discomfort, mathematical models and forecasts became the basis for economic policy discussions in Washington and among the Board staff. Always the consensus seeker, Martin submitted.
 &

Meltzer again emphasizes that the economy and inflation followed the monetary aggregates, especially the real monetary base, not the federal funds rate or free reserves.

The System recognized that it was in fact lender of last resort to the entire financial system. Thrifts, savings banks and insurance companies as well as member banks would be accommodated. The System agreed to lend to the Treasury so the Treasury could lend to the home loan banks.

  The FOMC was alarmed enough to issue a more restrictive directive by April 1966. By summer, the real monetary base was in sharp decline. M1 growth declined modestly, but the economy reflected the more pronounced decline in the growth of the real monetary base. Market interest rates moved higher as tight monetary policy clashed with exuberant loan demand, then eased as the economic growth slowed appreciably. Meltzer again emphasizes that the economy and inflation followed the monetary aggregates, especially the real monetary base, not the federal funds rate or free reserves.
 &
  Administered alternatives to market mechanisms do not fare well in  volatile times. Unintended consequences afflicted interest rate controls and credit allocation schemes.
 &
  Rising market interest rates reached levels where they threatened the business model of the thrifts. The income the thrifts earned from mortgages was suddenly no more than the interest cost of their deposits. Mortgage money dried up and the housing industry declined over 35%. There was a political uproar. Banks were selling their municipal bond holdings to raise funds to make loans at higher rates of interest. This drove down the price of existing municipal bonds and drew loud complaints from state and local governments.
 &
  Further increases in interest rates were politically risky. Faced with market interest rate increases and a federal funds rate at 5.45% heading up to almost 6% that November, Regional Reserve Banks that summer started requesting approval of further discount rate increases. The Board rejected the requests. However, it did impose increased reserve requirements on the larger banks.
 &
  Various elements of the financial system were too inflexible to keep up so there was widespread distress. That summer, the System recognized that it was in fact lender of last resort to the entire financial system. Thrifts, savings banks and insurance companies as well as member banks would be accommodated. The System agreed to lend to the Treasury so the Treasury could lend to the home loan banks.

  "This is the first explicit recognition that the System was the lender of last resort to the financial system. It was only one hundred years after Bagehot." See, Meltzer, History of Federal Reserve, v. 1 (1913-1951), Part I, "The Search for Monetary Stability (1913-1923)," at segment on "Central banking and the business cycle."

Keynesian Arthur Okun ultimately recognized the political rigidity that limited the possibilities for counter-cyclical fiscal policy. "We don't know as much as we used to think we knew," he confessed in the 1980s.

Nobody in the government was acknowledging the difference between real and nominal interest rates, that inflation always led to higher interest rates and higher unemployment rates, or that ending inflation was the only way to permanently drive interest rates and unemployment rates to lower levels.

  As in 1929, the Board also tried to allocate credit by jawboning and restricting access to the discount window. Once again it was in intentional denial of the fungible nature of money and credit.

  "The new regulation brought out the classic split between the market concerns of the reserve banks and the Board's political concerns that was present from the start of the System. [N.Y. Fed president] Hayes opposed the Board's recommendation. He recognized the central flaw. If the volume of reserves remained unchanged, credit would be available from other lenders. Large corporations would be able to obtain elsewhere funds denied by the banking system."

  As in 1929, jawboning and credit controls were both disruptive and ineffective. Meltzer describes the jawboning, threats, releases from commodity stockpiles and other measures actively and widely employed in the vain efforts to enforce price and wage guideposts. The Keynesians were blind to the obvious fact that controlling individual prices could do no more than shift excess demand elsewhere, and could not be maintained without measures that would broadly reduce demand. They kept trying to douse the fire in individual trees while the fire spread to the whole forest.
 &
  Nobody in the government was acknowledging the difference between real and nominal interest rates, that inflation always led to higher interest rates and higher unemployment rates, or that ending inflation was the only way to permanently drive interest rates and unemployment rates to lower levels.
 &
  Ultimately, Keynesian Arthur Okun, who became chairman of the Council of Economic Advisers in 1968, recognized the political rigidity that limited the possibilities for counter-cyclical fiscal policy. "We don't know as much as we used to think we knew," he confessed in the 1980s, after Keynesian policies had condemned the nation - and the world - to suffer the Great Inflation and the 15 year aftermath of high real interest rates and slow growth needed to squeeze out inflationary pressures.
 &

  The System was once again whipsawing the money markets, interest rates and the economy in its efforts to micromanage and stabilize the economy. As usual, these efforts would get increasingly frantic as control was lost. There was constant tinkering with bank reserve requirements and shifts in open market policy. Meltzer provides his usual detailed account.
 &
  Price inflation rose into 1966, declined precipitously into 1967 as economic growth slowed, and then bounced back with increased vigor in the first half of 1967 as the economy surged forward. The CPI reflected these price movements one quarter earlier than the GNP deflator. The economic growth peak was in the third quarter of 1966 and fell back until the summer of 1967. However, GNP never turned negative and unemployment remained below 4%.
 &
  Nevertheless, the System could not stand the political heat from even that modest economic slowdown. It surrendered its efforts at restraint at the first whiff of rising unemployment.
 &

  The administration agonized over the needed tax increase for two years. Meltzer provides a blow-by-blow account. Johnson finally made the request to Congress in August 1967.
 &
  Meltzer compares the economic scope of the first two years of Vietnam and Korea. The economic scope was similar. Vietnam cost twice as much but GNP had more than doubled. Judged by nominal standards and free reserves, monetary policy was more restrictive during Vietnam. Judged by the real - inflation adjusted - monetary base and interest rates, Vietnam policy was much more inflationary. Of course, Great Society spending and the delay in raising taxes made the budget deficit far greater and more inflationary during Vietnam.
 &

  Martin was reappointed chairman of the System Board in 1967. There was now a substantial majority of Keynesians on the Board and in the staff, so he constituted just a useful figurehead of monetary rectitude.
 &
  Between April and November, 1967, the System increased its portfolio of securities by almost $6 billion as it strove to keep interest rates in check. This was about 12% of the monetary base. Ominously, the spread between bills and long term Treasuries was widening, reflecting increasing inflationary expectations.
 &
  Nevertheless, the Keynesians in the Council of Economic Advisers were still pushing for a discount rate cut. Although the monetary aggregates were increasing explosively, the administration kept putting pressure on the FOMC to cut rates after the expected tax increase was passed.

  "On August 3, the president requested enactment of a 10 percent tax surcharge, effective October 1. Congress delayed nine months before passage. By that time the annual rate of consumer price increase had reached 4.5% on its way higher. Monetary base growth was above 6 percent. The unemployment rate soon reached 3.4 percent, the lowest rate since 1951-53. Unemployment did not approach that level again until 2000."

The Keynesian infection by now had spread throughout all arms of the government, as had liberalism, and there was no enthusiasm for restraint even as all economic indicators flashed inflation warnings.

  The primary reasons for the delay, Meltzer points out, included continued lack of administration unanimity on the need, congressional and department feuding over the accompanying spending cuts and Johnson's lack of enthusiasm for cuts in his Great Society programs.
 &
  Meltzer emphasizes that at this time the costs of Vietnam were already well known and so uncertainty cannot be blamed for the reluctance to pay for them. The Keynesian infection by now had spread throughout all arms of the government, as had liberalism, and there was no enthusiasm for restraint even as all economic indicators flashed inflation warnings. The FOMC was paralyzed by fear that monetary restraint might relieve pressure on Congress to pass the tax bill, so nothing was done.
 &
  Martin remained very sensitive to Johnson's opposition to tighter money and higher interest rates. Martin strongly advocated in favor of the tax increase and spending cuts in his public statements and congressional testimony, providing clear warnings of the inflationary consequences and the threat to the mortgage market and the dollar of failure to act.
 &

  Inflation expectations strengthened both at home and abroad as markets evaluated this sorry scene. Gold reserves were hemorrhaging. The impact on long term interest rates was dramatic. Treasury yields increased by ½% to 5.4% in just the last quarter of 1967. This was the highest rate since 1920. The GNP deflator hit 6.5%. A devaluation of the pound shifted pressure to the dollar in November and provided a good excuse for a belated half point increase in the discount rate.
 &
  Martin now realized that price inflation had become entrenched. 1968 was an election year, and Congress was in spending mode. Social security benefits, the minimum wage rate and federal pay were increased.
 &

  Keynesian hubris drove the System and the rest of the government further into economic micromanagement efforts. Although the System already was burdened with a variety of inconsistent objectives, it was driven to undertake additional objectives requiring administered alternatives to market mechanisms.

  "Housing, the thrift industry, credit, and income distribution became matters of political concern and, in turn, Federal Reserve concern. The objective of protecting the internal value of the currency gave way to new and diffused objectives. There were always reasons for delay to avoid one or more of the costs of disinflation. And some of the injured groups were politically active and able to bring their concerns to the Congress and thus to the Federal Reserve."

Controlling an interest rate - as Martin feared - left monetary aggregates and prices free to surge higher.

  CPI inflation rose from 0% early in 1967 to a 7% annual rate in June 1968. The GNP deflator hit 7.9% in the first quarter of 1968. Base money growth ran between 6% and 7%, and gold reserves were hemorrhaging.
 &
  A Congressional Joint Economic Committee report recommended that M1 money growth be kept within a 2% to 6% range. It criticized the ambiguity of the FOMC directives. The report had no observable affect on System policy or procedure. The System "simply controlled interest rates and money market conditions and acted as residual buyer to clear the money market at the interest rate they -- or the manager -- chose." Controlling an interest rate - as Martin feared - left monetary aggregates and prices free to surge higher.
 &
  The FOMC response was to again constrain free reserves and allow the federal funds rate to rise. The federal funds rate soared 1.5% to a record 6.12% rate in the five months to May, 1968. Nevertheless, the rate remained substantially negative in real terms behind the rate of price inflation. The Board increased member bank reserve requirements in January, 1968.
 &

  The last 25% gold reserve requirement - for Federal Reserve notes - was removed by Congress in March 1968, and the major central banks other than France agreed to confine their gold transfers to central bank transactions. They would no longer intervene in world gold markets. The gold shield against price inflation was almost completely gone. Bretton Woods was dead and merely awaited formal burial.
 &
  The Board accompanied this action with a half point discount rate increase to 5%. By the end of April it was at 5.5%. Federal funds rose to 5.7% and Reg. Q ceilings were also increased. Treasury bill rates rose to 5.25%. As the financial train wreck became increasingly apparent, Okun joined Martin in repeatedly advocating the tax increase.
 &

  The 10% surtax bill passed on June 21, retroactive to the beginning of the year for corporations and to April 1 for individuals. It was temporary - set to expire on June 30, 1969 unless renewed. There were $6 billion in spending cuts. Assassinations, riots, the Tet offensive in Vietnam and a lame duck president left the nation in crisis. Most of the spending cuts were in the military budget. Great Society spending continued to balloon beyond official expectations and out of control. There were riots in France and a devaluation of the franc. The Soviet Union invaded Czechoslovakia.
 &
  The Keynesians - including Okun and the System staff - predicted that the tax bill would have a major impact, with unemployment rising to 5%. Milton Friedman and the monetarists predicted little impact - but they were not in government.
 &

  The government thus reacted swiftly according to Keynesian fears of "fiscal overkill." Reality, as usual, perversely refused to conform to Keynesian expectations. Price inflation and economic growth remained high and unemployment remained low through the succeeding year. Market interest rates moved lower in anticipation of the tax bill but moved up thereafter.
 &
  There was great ferment among academic economists and policy officials throughout government concerning the impact of the tax and the appropriate monetary policy response. The Keynesian forecasts had widespread influence among government policy officials. Meltzer provides extensive details.
 &
  Martin and the Board wanted a half point discount rate reduction but the Regional Reserve Banks rejected it or wanted just a quarter point reduction. The Banks stressed inflation, the Board feared unemployment. The discount rate was reduced a quarter point to 5.25% in August 1968.
 &

  The discount rate reduction was an unmistakable signal. Although small, it unmistakably demonstrated that the System had no stomach for a serious fight against inflation. Market interest rates moved higher instead of following the discount rate down. Annual growth of the monetary base increased to 6.5% in October, the highest rate since January 1952. By December, the continuation of inflationary growth was unmistakable, the 1968 election was behind them, and the System increased the discount rate back to 5.5%. The stock market peaked that December, and Richard Nixon was the President elect.
 &

"[Economics] is not the science that provides reliable quarterly forecasts. Economists could not accurately adjust the economy using a simple Keynesian -- or other -- model to coordinate policy actions to move along a stable Phillips curve. Not only were the forecasts inaccurate and control imperfect, the expectations set off by the policy action worked against the attractive but unattainable goal in practice of slowing the inflation rate without causing a recession."

  Meltzer points out "the most basic failure" of monetary policy during the Kennedy/Johnson administration.

  "[Economics] is not the science that provides reliable quarterly forecasts. Economists could not accurately adjust the economy using a simple Keynesian -- or other -- model to coordinate policy actions to move along a stable Phillips curve. Not only were the forecasts inaccurate and control imperfect, the expectations set off by the policy action worked against the attractive but unattainable goal in practice of slowing the inflation rate without causing a recession."

  Even more important was the fundamental error of viewing chronic inflation as a problem of economic policy. Chronic inflation is always a problem of political policy, over which economists have little influence.

  The System under Martin had become an enabler of budget deficits. He succumbed readily to Kennedy/Johnson administration political pressure. His approach was to painstakingly build consensus before acting, to try to coordinate System policy with congressional and administration policies expressed in the budget, to accommodate Treasury fixed price financing operations by maintaining level "even keel" interest rates for them, and to accept System subservience as a mere creature of Congress. Independence was reduced to little more than being an independent adviser with regular access to the president, Congress and administration officials, responsibility for the techniques of monetary policy, and freedom to respond quickly to emergencies.

1969-1970 recession:

  The System had shifted to a policy of monetary restraint by the start of the Nixon administration and maintained that policy without substantial further action through June 1969.
 &

Bank commercial paper borrowing in the domestic and eurodollar markets became a substantial method of evading reserve and Reg. Q requirements. 

 Economic growth thus came to a halt in the second quarter of 1969, but the Board raised the discount rate to 6% in April, causing all kinds of problems with Reg. Q and other rigid interest rate arrangements. The Board also increased member bank reserve requirements. Bank commercial paper borrowing in the domestic and eurodollar markets became a substantial method of evading reserve and Reg. Q requirements. 

  "[Both] bank credit and money were affected in different ways by the regulation Q ceilings. With market rates at the ceiling, banks lost time deposits to their foreign branches and foreign banks and to non-banks at home. This had a large negative effect on credit growth and a smaller positive effect on growth of demand deposits and money. Banks had to buy back their deposits by issuing commercial paper and acquiring euro-dollars. Raising the ceiling rate would have avoided these changes."

"Banks tried to avoid monetary policy by using letters of credit, selling assets with puts attached, selling to foreign branches, and issuing commercial paper."

  Base money growth declined from December 1968 through April 1969, providing a clear signal of monetary constraint and economic contraction, Meltzer points out. However, at that time, nobody watched what Meltzer calls the "base money" aggregate. M1, bank credit and other monetary indicators were ambiguous, declining and then recovering during this period. This ambiguity caused much confusion within the System. 

  "Banks tried to avoid monetary policy by using letters of credit, selling assets with puts attached, selling to foreign branches, and issuing commercial paper."

  The System obtained legislative authority over commercial paper borrowing at the end of 1969. Soon thereafter it imposed a 10% reserve requirement. Reg. Q rates on time deposits were raised in January 1970.
 &
  The federal funds rate had climbed to almost 9% by June, 1969. The growth of the monetary base declined from over 7% to 5% in July and kept falling. The stock market was in substantial decline. Unemployment remained below 4% and CPI inflation increased to an annual rate of 5.3% by midyear.
 &
  Regional Reserve Banks were asking approval of discount rates as high as 7%. Federal funds were about 9% that summer. It was again a no-brainer for member banks to borrow from the System for 6% and lend in the money markets for 9% and higher. Discounts reached well above $1 billion. The impending recession became evident that summer, but inflation rates remained stubbornly high, causing growing impatience with System monetary policy.
 &
  The FOMC was again torn between its conflicting objectives. CPI inflation remained at about 5.3% during the third quarter. The GNP deflator was at 6.2%. Martin and other System officials feared that any immediate policy reversal would reinforce inflationary expectations. Independent economists were equally at odds. The Board was loath to raise the discount rate further. It yet once again resorted to jawboning efforts to get banks to allocate credit away from "speculative" uses. "Moral suasion" was again System policy.
 &
  Long term Treasury bonds reached 6.9% in August. Market interest rates were now clearly positive, far enough above the rate of inflation to be restrictive. The recession was now widely forecast. How high would unemployment go? CPI inflation was nevertheless still rising. It reached 6% in January 1970 and peaked at 6.16% in February.
 &

Martin had maintained restraint under a "no change" policy to the end of his term, but the result was too little, too late.

Martin recognized that he had failed both with respect to inflation and the dollar exchange rate. Of course, this failure was attributable to the entire government and its Keynesian policies.

  By February 1, 1970, Arthur Burns was chairman of the System Board, and the recession was already in its second month. Martin had maintained restraint under a "no change" policy to the end of his term, but the result was too little, too late.
 &
  There was already widespread decline evident in all the indicators, but the pro-cyclical policy was this time intentional. Martin left a mild 11 month recession - and no program for dealing with price inflation. Martin recognized that he had failed both with respect to inflation and the dollar exchange rate. Of course, this failure was attributable to the entire government and its Keynesian policies.

  "The FOMC had lost much of its innocence. It now recognized the mistakes it had made by permitting rapid monetary expansion in 1967 and following the surtax in 1968. Policy coordination had worked for the political benefit of the Johnson administration but not for them. The members saw more clearly than ever before that inflationary anticipations affected interest rates. And several saw clearly that there was no easy, painless low-cost way of reducing inflationary expectations. Past mistakes would prove costly to correct. Failure to pay the cost now would defer the cost and probably increase it."

The end of Bretton Woods:

 &

  The Bretton Woods fixed exchange rate standard had brought widespread prosperity among first world nations. The 1960s remained prosperous even as the system collapsed. The mean inflation rate within the system was just under 4%. However, by the end of the Kennedy/Johnson administration, Bretton Woods was a fiction.
 &

  A variety of trade liberalization measures, rapid technological advances and the advent of the European Common Market supported prosperity, but Meltzer points out that the economic performance never equaled that under the gold standard prior to WW-I.
 &
  The real - inflation adjusted - price of gold had actually declined to 1929 levels by 1959, wiping out the nominal price increase of 1934. The real price continued to decline into 1971 to the lowest levels in System history. Nominal increases in the gold price could have restored fixed exchange rates for awhile, but ultimately would have collapsed since Keynesian policies would inevitably have resulted in a series of disruptive devaluations. In the 1960s, U.S. economic competitiveness was actually not as far out of line as it would become in the 1970s under floating exchange rates.

  "The main problem in the 1960s was not a U.S. current account deficit. Throughout the 1960s, the United States typically had a surplus on current account. The problem was that the trade and current account surpluses were not large enough to finance private investment abroad plus military, travel, and foreign aid spending abroad."

  In both the 1920s and 1960s, advanced nations proved unwilling to accept the large but temporary business cycle losses of employment needed for monetary stability - so they ultimately got large chronic levels of unemployment instead as their economic policies drove the economic system into the inflationary morass.
 &

"The records of the period suggest a growing sense of resignation, belief in the inevitability of a breakdown."

Private warnings were circulating widely, but were officially disparaged. As usual, the government intended that the poor and poorly informed would bear the full cost of the crisis.

  Kennedy/Johnson administration policymakers never developed a lasting solution. Instead, they fudged - imposing various additional capital controls with each new crisis - posturing to kick the can down the road. Meltzer sets forth the proposals and measures implemented in considerable detail. As always, such administered alternatives to market mechanisms proved futile.
 &
  Higher interest rates could have cured the problem by supporting the dollar and reducing economic activity to reduce imports. However, the resulting increase in unemployment was not politically acceptable, so they tried administered alternatives instead. They tried capital controls and efforts to get the primary surplus nations, Germany and Japan, to adopt similar disastrous Keynesian policies.

  "As is often the case, markets circumvented controls and regulations. A main reason in this case was that the availability of substitutes undermined control programs. The public reacted negatively to controls, and officials were unwilling to introduce stronger measures that might have succeeded in prolonging the system. The records of the period suggest a growing sense of resignation, belief in the inevitability of a breakdown."

  Like incompetent generals prepared only to fight the last war all over again, economic policymakers were fixated on avoiding deflation and a return of the Great Depression. Inflation repeatedly caught them by surprise. Meltzer explains that there was simply no solution to the balance of payments problem while Keynesian policies were being invoked to stimulate economic activity. The increasing foreign commitments of the Cold War added to the international payments outflow.

  Great Depression fears were unfounded since the conditions that caused the Great Depression no longer existed - something Keynesian and other left wing economists effectively misrepresented. See, Summaries of Great Depression Controversies and Facts, "The Great Deception.")

  The control efforts did, however, increase both regulatory and reporting requirements on international commerce, at some expense. Controls on private commerce were readily circumvented, but "Buy American" controls on aid reduced the value of the assistance. The inevitability of devaluation was becoming increasingly evident, but government officials and advisers were effectively prohibited from discussing it. Private warnings were circulating widely, but were officially disparaged. As usual, the government intended that the poor and poorly informed would bear the full cost of the crisis.
 &

Another failure for the administered alternative:

  The lack of true independence, according to Meltzer, was the primary reason for System failure during this period.
 &

"Missing from most explanations by economists is the political dimension," Meltzer points out. The real cause of the failure was the lack of political and popular support for the anti-inflation effort.

  The System felt obligated, prior to 1980, to accommodate administration budget deficits by helping to finance them. After 1980, it no longer felt this obligation, and much larger deficits did not prevent a decline in price inflation or recovery from the deep 1980-1982 recession.
 &
  Of course, Reagan was willing to spend the political capital to support the Volcker System's anti-inflation efforts. Meltzer understands that the System, as just a statutory agency, is a mere creature of Congress and cannot act with true independence without support from elected political leaders. "Missing from most explanations by economists is the political dimension," he points out. The real cause of the failure was the lack of political and popular support for the anti-inflation effort.
 &

Congress could never be satisfied, and the initial modest credit allocation schemes were persistently increased, leading ultimately to the 2007-2009 credit crunch recession when the housing bubbles burst.

  The System couldn't even balance the inconsistent objectives it already had, but nevertheless was obliged by political pressure to adopt additional inconsistent objectives. Mortgage interest rates pushed by inflationary pressures above 6% in 1968 and thereafter had a serious impact on the housing market. From 1966 on, the System and other financial regulators came under increasing congressional pressure to allocate credit into the housing market. Of course, they had to succumb to that pressure. However, Congress could never be satisfied, and the initial modest credit allocation schemes were persistently increased, leading ultimately to the 2007-2009 credit crunch recession when the housing bubbles burst.

  "Adding homebuilding to a list of objectives that included sustained growth, full employment, low inflation, and international balance almost assured failure to reach most or all of the objectives."

Monetary policy was fatally hobbled by faulty Keynesian theories like the Phillips curve and cost push inflation, and the ridiculous Keynesian theory itself. Inherently incompetent mathematical models persistently provided faulty forecasts.

  Furthermore, the System really didn't know what it was doing. The System was just reacting to the money markets and trying to influence its direction along some desired path. Monetary manipulation policy proved far easier in the contemplation of naïve academics than it turned out to be in practice.

  "[The] members of the Board and the FOMC did not have a common framework or way of thinking about monetary policy. Neither Martin nor Burns made any effort to develop an agreed-upon way of thinking about how their actions influenced prices, employment, and the balance of payments."

  Fear of inflationist influences in Congress remained throughout this period - as in the 1920s - a constraining factor in the targets they could use for monetary policy.

  The System kept switching between targets and indicators in its increasingly frantic efforts to maintain a grip as the financial situation spun out of control. It focused on money market targets and nominal instead of real interest rates. It neglected the monetary aggregates. It was fatally hobbled by faulty Keynesian theories like the Phillips curve and cost push inflation, and the ridiculous Keynesian theory itself. Inherently incompetent mathematical models persistently provided faulty forecasts.
 &

"The Federal Reserve was better able to control inflation when the president was named Eisenhower or Reagan than when he was named Johnson, Nixon, or Carter."

  The private money markets were not fooled. Smoothed real growth rates fell as real long term interest rates rose and rose as real long term interest rates fell. The risk premium between high grade and lower grade bonds increased during the Great Inflation recessions and fell during recoveries as risks rose and fell, but they didn't recover to the lows at the beginning of the Great Inflation period until the 1990s.

  "Three morals stand out: you cannot end inflation (1) if you don't agree on how to do it; (2) if you and the public think it is less costly to let it continue; and (3) if you are overly influenced by politics. The Federal Reserve was better able to control inflation when the president was named Eisenhower or Reagan than when he was named Johnson, Nixon, or Carter."