Ben Bernanke is likely to be replaced soon as chair of the Fed and a debate has begun about the qualifications of his replacement. The conservatives want an inflation hawk. “Are you willing,” they will ask, “to jack up interest rates to fight inflation when unemployment gets below 6.5 percent?” Never mind that unemployment fell to 3.9 percent late in the Clinton administration and inflation never appeared.
So what should Bernanke’s successor know about inflation that essentially disappeared in the U.S. in 1983. The conventional wisdom is that the Fed and Ronald Reagan killed it with high interest rates and a recession. As a political matter, the inflation hawks often attribute the drop in inflation from 12.5 percent in 1980 to 3.8 percent in 1982 to Reagan’s courage in backing Volcker. This narrative serves the purpose of linking Reagan mythology to monetarist orthodoxy.
The narrative is wrong, however, for thoroughly documentable reasons. First, it was Carter not Reagan who appointed Volcker a full 14 months before Reagan became president. Carter knew that Volcker would raise rates sharply probably causing a recession but told his counselors who advised against the appointment to let him worry about the politics.
The Federal Funds rate was 11 percent when Carter appointed Volcker in August 1979. By the time Reagan took office in January 1981, Volcker had pushed the rate to 20 percent (the prime was 21 percent) and rates never went higher. So contrary to the mythology, Carter took the political risks not Reagan. Indeed during the first year of Reagan’s administration Volcker brought the Federal Funds rate down from 20 to 12 percent, and pushed it down to 8.5 percent by the end of 1982. It took no political fortitude on Reagan’s part to tolerate a 60 percent decline in rates over his first two years.
Bernanke’s replacement also should understand that the Fed role in ending inflation three decades ago has been significantly exaggerated. A bigger factor over the 30 year period has been more intense competition in large sectors to the American economy as a result of legislation Carter pushed through.
Carter took on bruising political fights with Congress to end price fixing by airlines (1978) and trucking companies and railroads (1980). He opened the auto and steel industries to more intense competition (1980), as well as oil, natural gas, and electricity (1978) with the same anti-inflationary results. These were political fights in Congress against powerful interests that Reagan never had to take on.
Price fixing had been a fact in the case of railroads since the 1880s, and since the 1930s for trucking and airlines, but no president until Carter had the political courage to take on the incumbent interests. In doing so, Carter faced the ire of not only business interests like the truckers who were a constituency in every state, but also the railroads, air carriers, and AT&T. These anti-competitive business interests were backed by the Teamsters, the Railroad Brotherhoods, the airline Machinists and the Communications workers who also wanted to maintain regulated limits on competition. As a result of what Carter did to open these markets, price increases have been restrained ever since.
In the election year of 1980, Carter also broke the U.S. auto cartel —- the Big Three —- by refusing to protect American car makers from foreign imports even though the trade laws gave him a politically attractive way to do so. Ford, Chrysler and the auto workers wanted him to limit this competition, but Carter refused. This is why many working class Democrats in Michigan jumped to support Reagan in 1980.
In a fascinating twist, competition in autos led to the collapse of steel prices in 1982 because in a more competitive car market the Big Three stopped accepting price increases for steel that they could no longer pass on to consumers.
It also was Carter not Reagan who battled for two years to pass legislation that gradually expanded competition in natural gas, oil, and electricity. U.S. inflation was fueled by rising energy prices between 1972 and 1979 linked to OPEC and instability in the Middle East. The public blamed Carter for high prices while Reagan benefited from their long decline after 1980.
Carter’s appointees to the Federal Communications Commission also helped bring inflation down. They followed Richard Nixon and Gerald Ford’s appointees in gradually opening Ma Bell’s near monopoly. AT&T and its union lobbied hard to prevent competition from MCI and others but neither Carter nor his appointees flinched.
The bottom line is this. The uninformed will tell you during the debate about Bernanke’s successor that the country needs an inflation hawk at the Fed because monetary policy is what keeps inflation low. Tell them that what is being inflated is the role of the Fed and monetary policy and that maintaining intense competition throughout the economy is far more important. And when people repeat the myth about the courageous steps Ronald Reagan took to fight inflation, don’t buy it. Instead tell them about Carter’s record for which you can cite data from the Fed itself and legislative chapter and verse.