A Benjamin Cole post
Some say Allan Meltzer, the right-wing economist, Carnegie Mellon professor, and author of the well-regarded A History of the Federal Reserve is an acerbic fellow. Maybe so.
Nearly forgotten today, a younger version of Meltzer served as an Acting Member of President Ronald Reagan’s Council of Economic Advisers in 1988-9. Ten years after his stint on the CEA, Meltzer recounted the Reagan Days (1981-1989), in a piece entitled, Economic policies and actions in the Reagan administration.
Meltzer’s chastising study reads in part—
“Uncertainty and lack of a coherent monetary policy were not limited to 1981-82. During the years 1984-87, the Reagan administration shifted from a freely fluctuating exchange rate to encouraging dollar devaluation first by talk and then, in 1986, by increasing money growth. These actions were followed by a decision at the Louvre in January 1987 to set a band for the exchange rate against principal currencies. Within a few months, the dollar was overvalued relative to the agreed-upon rates, so maintenance of the band required increased money growth in Germany and Japan and lower money growth in the United States. The band required higher interest rates. Between July and October 1987 interest rates on long-term U.S. government bonds increased approximately 25 percent (from 8 1/2% to about 10 1/2%). When anticipations of further increases in interest rates contributed to a rather dramatic decline of prices on the world’s stock exchanges, the administration shifted its position again. The dollar declined about 8 to 10 percent below the presumed bottom of the previous band.
It is difficult to find a consistent pattern, much less a coherent policy, in these shifts within less than one year from efforts to force devaluation by raising money growth and lowering market interest rates to a program of stabilizing exchange rates, lowering money growth, and raising interest rates and then to a program of lowering interest rates and allowing the dollar to fall. The shifts suggest an extremely short-term focus….” (boldface added.)
From Meltzer’s perspective, the Reaganauts stomped on the monetary brakes in 1981, then once inflation slipped towards 5%, they gunned the accelerator again. Thereafter, they had an incoherent policy.
Okay, monetary policy was a mess, by Meltzer’s lights, although the curious placement of monetary policy within the Reagan Administration, and not within Chairman Paul Volcker’s somewhat independent Federal Reserve, is puzzling. Meltzer seems to imply Reagan called the shots, and Volcker complied. As in Fed Chairman Arthur Burns’ compliant dance with President Nixon.
But what about Reagan’s fiscal policy?
Here, Meltzer is again the scold.
“Why did the Reagan administration choose to run deficits that are large relative to previous peacetime experience in the United States? One possibility is that the deficits were not anticipated. This is improbable….”
Meltzer concludes the Big Reagan Deficits stemmed from increased spending, as tax receipts as a fraction of GDP stayed within historical ranges.
As a final slap, Meltzer also concludes Reagan “did very little to implement a deregulation policy. If we include protectionist actions affecting imports with deregulation, the Reagan administration’s record on deregulation is poor.”
Meltzer is a tough, even acid critic. But John Cochrane, University of Chicago scholar? Not so much.
Enter John Cochrane
Today Cochrane hails the Reagan-Volcker Team as Dynamic Duo Inflation-Busters.
At first blush, this is puzzling; Cochrane’s recent “Neo-Fisherite” stance declares the Fed can fight inflation by lowering interest rates, which sets off lower inflationary expectations—and voila! You get lower inflation.
In the comments section of his blog, I asked Cochrane about the accepted Fed Chairman Paul Volcker story, that an indomitable Volcker mightily raised rates and thereby broke the back of inflation.
That is not a Neo-Fisherite story line.
Cochrane replied, “The 1980s were a classic joint fiscal-monetary contraction….Tax reform, growth, led to large surpluses that paid off a handsome present to bondholders, and paid for a decade of high interest costs. Many monetary tightenings have failed without this fiscal support.”
No doubt, the reader is thinking, “What the beans is Cochrane thinking about? Reagan ran red ink like water over Niagara!”
Cochrane has a nifty definition of federal surplus that is kin to what business people would call an “operating budget.” That is, what is the profit or loss a business makes on operations, before debt payments. Cochrane’s point is that Reagan ran an operating surplus, also called a primary surplus—taxes were greater than operating outlays.
It is an interesting vessel of an idea, the only problem it also leaks water like Niagara. The Reagan deficits were so vast that even without debt payments The Gipper ran rivers of red ink.
Year Net Interest Payments Deficit
1981 $68.8 $ 79.9 billion
1982 $85.0 $128.0
1983 $89.8 $207.8
1984 $111.1 $185.4
1985 $129.5 $212.3
1986 $136.0 $221.2
1987 $138.6 $149.7
1988 $151.8 $155.2
2000 $222.9 +$236.2
Well, Reagan came close to a balanced operating budget in 1988, but no cigar, and most of his Presidency was a gathering ocean of red ink, even his primary budget.
The year 2000, btw, was President Clinton’s last year in office, in which he ran an operating surplus, or primary surplus, of $459.1 billion. One might ponder if any organization ever in history ran such a large operating gain.
Cochrane has been pushing a Neo-Fisherite stance, but too often he seems to run headlong into a granite wall of opposing empirical and historical facts.
As Meltzer points out, there was no coordination, or joint contraction, of fiscal and monetary policy in the Reagan Administration; Reagan ran big deficits and Volcker raised interest rates to the moon in 1980.
By luck or otherwise, inflation cracked quickly to under 5%, so Volcker eased up, as is seen in sliding interest rates and bulging M1 and M2 supplies in the 1980s. Meanwhile, Reagan kept running huge deficits.
This is not a Neo-Fisherite story. Monetary policy erratically eased and was joined at the hip with big federal deficits after 1981.
The Real Story
But the real story remains lost to Cochrane, and others, I fear.
The first real story is that the U.S. economy has evolved over the decades to one that is much less inflation-prone than the 1960s and 1970s. The last gasp of inflation was in the early 1980s, when Volcker slay it.
Now, Big Labor is dead, Big Steel too, Big Telecommunications, Big Oil, Big Autos, Big Anything.
International trade has exploded, reducing supply side bottlenecks and the possibility that an economy can “overheat.” The Wal-Mart import-a-rama scheme is the norm.
Americans would have to buy a lot of cars to allow global automakers to engage in price gouging. More than they could ever buy. Multiply that example a thousand times over, in every product category.
Meanwhile, top marginal tax rates have been cut in half, while financial, telecommunications and transportation industries have been deregulated. Capital is everywhere, gluts of it.
The Internet has made sourcing easy and global, and simultaneously opened local markets—second and grey-market goods are easily traded now.
The real story is inflation is dead.
The second real story is the one Market Monetarists know: A central bank that fixates on inflation or interest rates is not doing its job, which is properly focused on economic growth. Oh, that?
Yes, that. A central bank best obtains a good result on that by trying to keep nominal GDP growth on a steady growth path.
I guess that is just too easy.
PS: On May 6, Meltzer penned an op-ed in The Wall Street Journal to the effect that “Never in history has a country that financed big budget deficits with large amounts of central-bank money avoided inflation. Yet the U.S. has been printing money—and in a reckless fashion—for years.”
Inflation will wreck America, suggests Meltzer.
Some things never change.