Who Shot Down The Game Plan
Brozen, Yale
Who Shot Down The Game Plan? Yale Brozen When President Nixon took office in 1969, he promised "disinflation without depression." I was, to say the least, skeptical of the...
...The inflation of the last few years began in 1965...
...The Council of Economic Advisers was satisfied with this performance...
...1969-Nov...
...This meant that the period of deceleration would be protracted instead of being short...
...But then in mid-August, the Federal Reserve reported that its money growth rate figures were wrong (see Table 2...
...Prior to the 1953-54 recession, money growth was cut to a zero rate...
...Yale Brozen ~s a pro]essor o] business eConomiCs at the Graduate SChool of Business...
...3.7 4.8 5.6 Mar...
...annual rate in May...
...Our government has four branches...
...The Federal Reserve moved to cut money growth further to get down to the three per cent level...
...By mid-1969, it appeared that the Federal Reserve had accepted the administration's game plan...
...Because the Reserve's primary tool is open market operations -- buying and selling Treasury bills and bonds -- it has an operator of the Open Market Desk who is given instructions to buy or sell in order to achieve desired rates of money growth...
...He said, "But there aren't any tigers in Connecticut...
...1949...
...Paul McCracken, the chairman of the Council of Economic Advisers, remarked that being forced to depend on the Federal Reserve for data on money growth was like having to depend on the Mafia for crime statistics...
...The administration may propose a game plan for the economy, but it is the Federal Reserve which disposes...
...Instead of urging the Reserve to cut money growth to a three per cent rate from the eight to nine per cent rate that had prevailed before it took office, it began urging the Reserve to increase the money growth rate from the minus one and a half per cent level to which the Reserve had cut by Christmas 1969, It urged the Reserve ~ot only to increase it to a three per cent level but to push it on up to a six per cent level in order to stem the decline in the economy which had started...
...Even during World War II we had to constantly allow ceilings to rise because money growth exceeded this rate at that time (which it...
...TABLE ONE CttANGES IN THE STOCK OF MONEY 1947-1971 Date Money Change from { billions ) Preceding Year June 1947 $110.9 2.4 % June 1948 110.8 -0.1 June 1949 110.2 -0.5 Recession June 1950 112.9 2.4 June 1951 117.6 4.2 June 1952 124.2 5.6 June 1953 127.6 2.7 June 1954 129.0 I.I Recession June 1955 133.5 3.5 June 1956 135.1 1.2 June 1957 135.9 0.6 June 1958 137.4 I.I Recession June 1959 142.4 3.6 June 1960 139.3 -2.1 June 1961 142.1 1.9 Recession June 1962 145.2 2.2 June 1963 149.0 2.9 June 1964 154.2 3.4 June 1965 160.8 4.3 June 1966 170.0 5.7 June 1967 175.7 3.4 Mini recession June 1968 188.5 7.3 June 1969 200.5 6.4 June 1970 207.8 3.6 Recession June 1971 223.6 7.6 Source: FEDERAL RESERVE BULLETIN, ,June, 1964...
...The international financial system built with such effort at Bretton Woods and so painfully maintained since the end of World War II has now collapsed because of the Reserve's criminally inept attempt to hold interest rates at the four per cent level last April and May...
...You see, every inflation is caused by an increase in the quantity of money outrunning the increase in production...
...Members of the administration and the Council were furious with the Reserve...
...The administration's game plan had already been derailed by the Reserve...
...To stop the inflation, then, we had to slow the rate of money growth...
...As usual, fifteen months of declining rates of money growth were followed by a recession - - a recession which began in November 1969...
...From 1960 to 1964, the stock of money grew at a rate of two to three per cent per year...
...Inflations a r c caused by too much money chasing too few goods...
...Prior to the 1960-61 recession, money growth was cut to minus three per cent...
...Recession began in December 1969, although no one knew at the time that it had arrived...
...It was summer, the coach was not air conditioned, and the passengers opened the windows for some relief from the heat...
...1970 THE MILDEST RECESSION YET I must say, this administration has come closer to pulling off the trick than I had believed possible...
...In every previous case of slowing money growth when attempting to halt inflation, the Federal Reserve has always gone too far in decelerating money growth...
...In addition to the usual three branches discussed in government courses - - the executive, the legislature and the judiciary - - there is a fourth branch called the Federal Reserve System...
...After two months of observing this behavior, he sat beside the man throwing the bits of paper out the window one morning and asked, "'Why do you do that every day riding in to New York...
...He commuted on the New Haven Railroad each day to his job in New York...
...The Reserve pegged Reserve funds and bill rates at a four to four and a quarter per cent level in order to keep interest rates from going to seventeen per cent...
...Couldn't it have allowed interest rates to go to five or six per cent rather than pump money in at a sixteen per cent annual rate...
...Now you know why...
...Especially, how were we going to end the longest period of sustained inflation suffered in the postwar era, with all the inflation momentum that had been built, without a recession...
...In that one, unemployment rates peaked at six and nine-tenths per cent in March and May 1961 (eight and one-tenths per cent not seasonally adjusted in February 1961...
...December, 1970...
...Prices began rising in 1965 at a faster rate, nearing a three per cent rale of increase in the last quarter...
...That prevents the President from appointing his majority to the Board until: shortly before he leaves office at the end of eight years - - assuming he serves two terms...
...Maximum unemployment of five per cent at the end of 1970 was expected to be the peak...
...The bitterness was understandable since the Reserve's failure to cut the money growth to three per cent as it had reported doing meant that further cuts in money growth would have to be made to bring inflation under control...
...1969 May, 1968 5.7% June 6.8 July 7.9 8.4% Aug...
...July 1953-August 1954...
...That would avoid protracting the deceleration over a thirteen to fifteen month period that would be likely to bring on a recession...
...The Reserve did not go to a six per cent target until late 1970 when the economy had already bottomed...
...The administration's reaction was understandably bitter...
...I should add that the freeze will not work if the Reserve does not stop pumping money into the economy...
...They will work then, however, primarily in the same way that householders in Connecticut used to be protected from tigers...
...The recession was, however, the mildest yet experienced in American economic history...
...Nov...
...or stem gold outflows or reduce balance of payments of deficits or encourage construction, etc...
...I was, to say the least, skeptical of the likelihood of this being accomplished...
...1969 Oct...
...It had failed to follow the administration's second game plan and had allowed a recession to develop...
...Money growth rates were reported by the Federal Reserve as having been cut from the eight and one-half per cent rate of mid and late 1968 to a three per cent rate...
...In January 1970, money growth moved to a primary goal position for the first time...
...October, 1969...
...Their plan was based on the expectation that steps could be taken which would end the inflation without forcing unemployment above a four and five-tenths per cent average for 1970...
...1970 7.0% 7.8 8.7 8.6 8.4 8.3 7.7 7.6 6.8 6.9 6.7 6.9 5.7 5.1 5.0 3.3 2.7 2.2 1.9 1.2 at which money is pumped into the economy would then be held stable at this level...
...May 1960-February 1961 Nov...
...They were given in terms of stabilizing interest rates at some desired level...
...1967...
...It has primacy in governing the economic health of the nation...
...Foreign central bank holdings of dollars doubled between February and July...
...Six of the seven members now serving on the Board are appointees of previous administrations - - the same men whose actions caused the inflation with which we have been living...
...4.8 5.6 5.7 April 5.9 6.4 6.7 May 3.5 4.3 4.9 June 2.4 3.8 4.4 July 3.9 3.6 Aug...
...On 15 January 1970, a revolution occurred at the Reserve, partly in response to the pressures from the administration and partly in response to several years of nagging from the Joint Economic Committee of the Congress...
...Unfortunately, no one can forecast that accurately...
...1970 The mini recession in the first half of 1967 was preceded by a decline in the rate of increase in the money stock from 5.2 per cent in 1956 to 1.3 per cent in 1966 I Jan...
...They argued vehemently in late 1969 for stepping up the rate of increase in the money stock to at least three per cent before it was too late...
...It is independent of the other three branches...
...What went wrong...
...On 15 January 1970, it started trying.'" Always before January 1970, the Reserve had made stabilization interest rates at some desired level its primary goal...
...My friend was a bit startled, to say the least...
...If it takes a slowing in monetary growth to stop an inflation, and if a thirteen to fifteen month continuous deceleration is always followed by a recession, how were we going to stop inflation, then, without producing a recession...
...The recession had started...
...Could it not have tested the effect of a small rise in interest rates rather than stubbornly insist that they would go to seventeen per cent unless it pumped money in at this incredible rate...
...6.8 7.4 8.0 Oct...
...Chastened by the consequences of its bumbling behavior, the Reserve not only adopted the six per cent target for money growth in late 1970, it went to a seven and a half per cent target in the first quarter of this year in an attempt to undo the damage it had done...
...6.3 7.2 7.4 Dec...
...1948-Oct...
...Here the story becomes a little complicated...
...The Reserve projected a rise in short term rates to seventeen per cent unless it provided funds to meet these demands...
...6.2 6.9 7.1 Jan...
...Dec...
...It would be more likely, as a consequence, to bring on a flattening in the growth of the economy or even a recession -an outcome that the administration ardently desired avoiding...
...It pumped money into the market in such volume that the stock of money grew at a sixteen per cent...
...As a consequence, it had to readjust its game plan to aim at that objective...
...It m much more difficult to stop a recession than it is to avoid one in the first place...
...Instead unemployment averaged nearly five per cent in 1970 and unemployment hit a peak of six and two-tenths at the end of 1970...
...In 1965, money growth was stepped up to five and one-half per cent and prices accelerated to a three and five-tenths per cent rate of rise in 1966...
...It then picks that level of interest rates which it believes will result in the desired rate of growth of money...
...This meant that inflation would not be brought down to a one to two per cent level within three years but only to a three to four per cent level, an unacceptably high rate...
...The Reserve tried to get back on the track in early 1970, six months too late...
...MONTH RATES OF MONf=Y GROWTII 1971 January 1.1% February 14.9 March 14.9 April 9.7 May 16.3 June 9.5 July 10.6 August 2.7 August 2.7 September -3.6 October -2.6 Again, it was late in going to the administration's game plan, this time not by six months but by almost a year...
...6.5 7.5 7.4 Nov...
...plan was to slow monetary growth to a three per cent rate well within a twelve month period after the peak rate of 1968...
...This, however, is not the end of the story...
...The Reserve forecasts what rates of money growth will be associated with various levels of interest rates...
...European banks and companies were borrowing dollars in order to invest in marks and in British bills to profit from the ext pected revaluation and from the interest rate differential...
...Unemployment averaged six and seven-tenths per cent in 1961 compared to four and nine-tenths per cent in 1070...
...The Reserve picked interest rate targets it thought would result in a three per cent growth in money...
...Prices rose by little more than one per cent a year...
...Heavy demands for funds had come into the financial markets because of an expected revaluation of the German mark and because of attractively high interest rates in England...
...Anyway, in its foolhardy endeavor to meet the demands for funds without allowing interest rates to rise, the Reserve flooded foreign central banks in such a-tidal wave of dollars that the dollar was washed away as a reserve currency...
...Dec...
...Then in the second quarter, it adopted an eight to nine per cent money growth target for fear that rising interest rates would nip the recovery in the bud that had begun in December...
...It then clung to that target until summer when it grudgingly set a.five per cent target...
...The mildest recession previously experienced was the 1960-61 decline...
...President Nixon, for example, made his first appointment to the Board one year after he took office...
...As one of my friends later remarked, "The Reserve was organized 23 December 1913 to control the stock of money...
...1969 4.6 5.5 6.6 Feb...
...Each morning, as he rode the train to work, he noticed that one of the passengers kept tearing paper into bits and throwing them out the window of the coach...
...That was true in 1949, in 1953, in 1957 and in 1960 (see Table 1 ). Even the mini-recession of 1967 was preceded by ten months of declining monetary growth...
...July 1957-April 1958...
...The Reserve shifted to the game plan designed to limit unemployment to five per cent after unemployment had hit six per cent: It had failed to follow the administration's first game plan and had caused a downturn in the economy...
...At the Reserve's Open Market Committee meeting on that date, it issued an instruction to the operator of the Open Market Desk that he was to take those actions which would achieve a three per cent growth in the monetary aggregates...
...We have never licked an inflation in the past without a recession...
...July 1971 Recessions: Nov...
...Wouldn't a rise in the peg to five or six per cent have at least restrained the flood of money a little and yet have avoided the imagined seventeen per cent interest rate...
...The administration proposed that once the rate of money growth was brought down to three per cent, deceleration would be halted...
...During all of 1970, the administration had to worry about limiting the decline in the economy, Inflation took second place...
...This has, indeed, been a very mild recession...
...The administration was well aware, however, that its game plan had not been followed...
...That threatened to accelerate inflation from the four per cent level it was brought down to in the second quarter of this year (from the six and one-half per cent level at the end of 1969...
...Instead of following the administration's six per cent money growth game plan for this year, the Reserve dumped money into the economy at rates ranging between ten and sixteen per cent (one month changes annualized) from February through July...
...It is headed by a seven man Board of Governors who serve fourteen year terms - - one expiring every two years...
...It is a level consistent with a decei~ratien of inflation to a one to two per cent rate within three to four years from the then prevailing six and onehalf per cent rate without causing unemployment to go to recession depths...
...I t controls the supply of money...
...It was too late, however...
...The Reserve, however, clung to a three per cent target until spring of 1970 when it went to a four per cent target...
...We never know definitely that we are in a recession until it has gone on for six months...
...Far better" for whom...
...It followed an acceleralion in the rate of growth in money...
...His fellow passenger, continuing to tear up paper and throwing the bits out the window as he talked answered...
...The rate 6 The A l t e r n a t i v e J a n u a r y , 1972 TABLE TWO ANNUAL I~ATI,:S OF CHANC, I.: IN MONI.:Y STOCK FROM SIX MONTftS PI-.:IO!~ TO MONTH SttOWN Figures provided in July, 1969 Sept...
...In order to put the situation in perspective, I should first tell you that what you have learned about our government consisting of three branches which check and balance each other is wrong...
...8.5 9.0 8.6 % Sept...
...If the Reserve will turn off the money pump, then wage and price controls will work...
...Although the recently ended recession was very mild, and we have recovered to a record level of jobs (79,800,000) topping the previous record in the first quarter of 1970 by 800,000 the recession was more severe than the President and his advisors intended...
...The Council of Economic Advisors did its planning in 1969 on the basis of restraining any rise in unemployment, intending to keep it below the five per cent level...
...2.8 2.9 Sept...
...University of Chicago...
...However, every time we have decelerated money growth in the past, for thirteen to fifteen months, a recession has always followed...
...has done since August, but is overdoing at the moment, as usual...
...A friend of mine tells the story of an experience he had when he took a job in New York and set up his household in Silver Mine, Connecticut...
...However, the interest rate targets it picked turned out to generate a decrease in money in the last quarter of 1969...
...The administration's game...
...In late 1967 and 1968, money growth moved up to between seven and nine per cent and the rate of price rise accelerated to six and one-half per cent by the end of 1969...
...His fellow passenger answered, with a perfectly straight face, "'Keeps the tigers away...
...His instructions were not given in terms of money growth targets, however...
...1966 to Jan...
...See Table 3) 1 will never understand that episode...
...Again, it was too late to avoid the contingencies that the administration was trying to avoid...
...In 1969, during the year following this administration's assumption of office, money growth rates were cut from the nine per cent level of mid-1968 to one and two-tenths per cent by the end of 1969...
...2.5 Oct...
...The Federal Reserve has always over-reacted in trying to stem inflations or meet balance of payments problems in the past...
...Wage and price controls are unenforceable in the face of money growth exceeding two to three per cent...
...Did it need to hold interest rates at four per cent to keep them from approaching its-projected seventeen per cent...
...Prior to the 1949 recession, for example, money growth rates were reduced to a point where the stock of money actually decreased instead of being held stable at a three per cent rate of rise...
...At this rate of money growth, inflation would be pushed to a ten per cent rate within a year if the administration had not acted on 15 August to freeze prices and wage rates...
...It turned out that money growth had been cut to only five per cent instead of the three per cent that had been reported...
...This time, the administration hoped to persuade the Fed to avoid its typical over-reactions of the past and to avoid protracting the deceleration of money growth over such a long period that recession would necessarily follow...
...Unemployment rates went from three and five-tenths per cent in December 1969, to a six and two-tenths per cent peak in December 1970...
...It had cut the rate of growth too far and it had protracted the deceleration over too long a period...
...January, 1972 Who Shot Down The Game Plan ? Y a l e Brozen W hen President Nixon took office in 1969, he promised "disinflation without depression...
...Then, in latter 1964, money growth was stepped up to more than five per cent...
...It had+been subtracting some data adjustments twice when they should have been subtracted only once...
...WHAT WAS THE GAME PLAN...
...The A l t e r n a t i v e J a n u a r y , 1972 7 TABLE 3 ANNUALIZb.I) ONI...
Vol. 5 • January 1972 • No. 4
