The Great Depression Online

Great Depression Online Archive Issue:

When the Inflation Cat Gets Out of the Hat

Great Depression Online
Long Beach, CA
February 08, 2011

Inside This Issue You Will Discover…

*** The Quagmire of Stagflation
*** Economic ‘Tough Love’
*** When the Inflation Cat Gets Out of the Hat
*** And More

The Quagmire of Stagflation

About the time Saturday Night Fever was topping the billboard charts something equally impossible happened…inflation and unemployment simultaneously went vertical.  The leading economists of the day were flummoxed.  The Philips curve had told them there’s an inverse relationship between inflation and unemployment. 

How could it be that both were going up at once?

Of course, it took years of government tinkering to pull off such a feat.

When unemployment began creeping up in the 1970’s the U.S. Treasury, with backing from the Federal Reserve, did what Keynes had told them to do…they spent money to create jobs.  But instead of jobs, something unexpected happened. They got inflation.  When they tried it again, astonishingly, they still didn’t get jobs…they got more inflation.

~~~~~~The $300 Trillion Crisis~~~~~~

Let’s face it.  It’s really hard to get a straight answer from anyone anymore.

Our leaders keep talking about change and growth, but all around us, people are losing their life’s savings to corrupt corporations, losing their careers to unemployment, and losing their lives and families to non-stop work just to make ends meet.

It didn’t used to be like this.  Just a few decades ago, families had time to spend together, and a high school diploma was sufficient to get you a job that would allow you to live on your own.

So what happened? 


By the time Jimmy Carter left the White House, the Misery Index, which is the sum of the Unemployment rate and the Inflation rate, was rocketing toward 20 percent.  Only when the Country was firmly stuck in the quagmire of stagflation, was the brain trust finally willing to listen to Milton Friedman…a man whose ideas they’d rejected in the 1960’s.

Milton Friedman said, “Inflation is always and everywhere a monetary phenomenon.”  What he may have meant is that increasing the money supply at a faster rate than economic growth is, in fact, inflation; higher oil prices or wage increases can sometimes be the consequence, but they aren’t the cause.  So to end inflation, Friedman explained, monetary policy should tighten up the money supply.

This went counter to the Keynesian zealots at the time.  For tightening the money supply would be the death blow to an economy already staggering with high unemployment.  

Economic ‘Tough Love’

In August of 1979 Paul Volcker took the helm as Chairman of the Federal Reserve.  No time before or since has the Federal Reserve been Chaired by a man who did other than the politically expedient.

Volcker talked tough and acted tougher.  He recognized that before economic growth could return the inflation fire must be snuffed out…even if doing so meant higher unemployment in the short run.  In the face of brutal condemnation, which included being burned in effigy on the Capital steps, Volcker implemented Friedman’s policy of economic ‘tough love’.

Volcker raised the federal funds rate from 11.2 percent in 1979 to a peak of 20 percent in June 1981…sending the prime rate to 21.5 percent in 1981 and the economy into a severe recession. 

Remarkably, for two long years, as rates went up, inflation did too. 

But, finally, in 1983, inflation was controlled.  Soon after, economic growth returned, unemployment fell, and the United States enjoyed 25-years of near uninterrupted prosperity.

When the Inflation Cat Gets Out of the Hat

Economics is a dismal science, they say.  Taking the right action doesn’t immediately correct an economy that’s been distorted by years of wrong actions.  Conversely, taking the wrong action doesn’t often express itself in the economy until it’s too late.

Last week, in a Speech at the National Press Club, Federal Reserve Chairman Ben Bernanke dismissed inflation prospects.  Bernanke referenced core inflation, which excludes food and energy prices, to support his view that inflation is muted.  The problem, however, is that we all have to buy food and energy…and, if you haven’t noticed, food and energy prices are going up.

For example, the Food and Agriculture Organization released a statement last week that, for the seventh straight month, the FAO Food Price Index rose.  What’s more, in January 2011 it rose 3.4 percent from December 2010…the highest (in both real and nominal terms) since the index has been backtracked in 1990. 

By our quick back of the napkin calculation, food prices are increasing at an annual rate of over 40 percent.  But that’s not all… Crude oil prices are up 21 percent over the last seven months.  Before long, food and energy price increases will result in consumer price increases.  What will Bernanke do then?

If he waivers for only a moment it will be too late…consistent price rises create a self-reinforcing mentality of higher inflation expectations.  The experience of the 1970s showed that when the inflation cat gets out of the hat, getting it under control is very difficult.  It takes extreme measures, and immovable conviction, in the face of overbearing political opposition.

Bernanke, we fear, won’t be up to the task.


M.N. Gordon
Great Depression Online

P.S.  Over the years, I’ve watched as our lifestyle as Americans has deteriorated.  Yes, we have more stuff, but our quality of life has continued to diminish.  More and more of our time is spent working longer and harder for declining wages.  Yes, we have more entertainment, more technology, and better cars, but we have poorer, more desperate lives.  It’s almost as if something has been slowly crushing the life out of our economy.

The $300 Trillion Crisis

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