The End Of Monetary Policy As We Knew It, Part 2
In Part 1 we made clear that the Federal Reserve’s current modus operandi has nothing to do with the classical monetary policy remit it was granted by the 1913 statute. In fact, under the cover of the Humphrey-Hawkins Act of 1978 the Fed has transformed itself into the equivalent of a monetary central planning agency.
The latter act told the Fed to pursue full-employment and price stability but not because these salutary conditions were the presumed outcome of Sound Money, which they actually would be. Rather, the Humphrey-Hawkins Act, which passed the Congress as H.R. 50 in the 95th Congress, was a product of the primitive Keynesian bathtub theory of macroeconomics that was all the academic rage at the time.
That is to say, there was a presumed trade-off between inflation and jobs, known as the Phillips Curve. It was further held that left to its own devices market capitalism had no clue about how to achieve the delicate balance that would optimize employment and price stability. It was the job of the state, therefore, to ensure that the bathtub of aggregate demand was filled precisely up to the brim so that all labor and capital stock would be utilized without triggering a spill-over of excess demand and inflationary pressures.
In the original 1960s formulation the bathtub of aggregate demand was to be regulated by the fiscal authorities. If demand was deficient, deficit spending and tax cuts would be deployed to fill the tub up to the tippy top; and, in the unlikely circumstance of too much demand, temporary budget surpluses were supposed to drain the tub of too much spending power in the household and business sectors.
Fiscal Keynesianism of the 1960s didn’t work for numerous reasons, however. Foremost among them was Democracy!
That’s right. It would take months and even years for Congress to process legislation designed to stimulate or restrain the economy via shrinking/expanding the budget deficits/surpluses. By the time legislation got enacted, therefore, a mild recession might have turned into a thundering depression, or vice versa.
Accordingly, president Kennedy’s Harvard advisors even peddled the idea of granting the president authority to raise or cut taxes unilaterally, so as to resolve the timeliness issue. But that was a bridge too far for the old fashioned southern democrats who still held the balance of power in the Senate.
In any event, as the 1960s drew to a close it was evident that LBJ’s “guns and butter” policies had way over-stimulated the economy, causing the bathtub of GDP to flood and triggering the first severe peacetime inflation in modern times; and also that his attempted Keynesian remedy of spending cuts and tax increases to generate a large fiscal surplus in the spring of 1968 came too little and too late
In turn, that caused the sound money man than serving as Chairman of the Federal Reserve, William McChesney Martin, to do what he had to do: Namely, throw-on the monetary brakes, even after LBJ had threatened Martin with bodily harm.
Needless to say, the next President and most economically unprincipled Republican to ever occupy the Oval Office (before Donald Trump), was not about to let Martin’s recession cut his term in office to just four years. That was especially because Tricky Dick had nursed a grievance against Martin for a decade, believing that the short-lived recession of 1960 on Martin’s earlier watch is what KO’d his campaign against John Kennedy.
In short order Nixon fired Martin and found a far more pliant Fed Chairman in the person of Professor Arthur Burns. The latter sounded like a stern Germanic financial disciplinarian at the microphone, but was actually a supine toady in the rough and rumble of the Nixon White House.
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