Nixon Rides Again. Will panic rule policy again?

As the President and Congress take R&R after a grueling year of doing nothing, we might want to ponder what is going to come next in the way of policy. In the Financial Times letters to the editor section on August 22 there was a letter explaining that orthodox economics was no longer applicable – we need to try some novel approaches for our current economic problems. The President leaked that he has a great new plan that will be released with great fanfare at a future exciting prime time press conference.  As we all wait with bated breath, we might want to recall the 1970s. The 1970s are known for many things. While disco often comes to mind and I could write a whole blog about why I loved and still love disco, my macro background makes me recall the 1970s for macro reasons. For example, we had three recessions during the 1970s. The term stagflation was coined in the 1970s to describe a new form of economic disease that found inflation and unemployment rising at the same time. Perhaps as a result of the latter my most salient memory of the 1970s is how stupid macro policy was. And that brings us to today. I think we learned a lot about stupid policy in the 1970s and we are about to repeat those errors again. Why? Does history have to repeat itself? I wish it wasn’t so. But when people start to panic our friends in Washington feel obligated to follow suit. Unlike times when leaders like Roosevelt and Churchill met crisis with level heads and big cigars, our leaders run to Twitter and Tweet about how the other guy is a big poopy-head.

Nixon was a conservative guy. At least that’s what we thought. But then along came stagflation. Arthur Burns said to Richard one day – Richard, let’s go break into a building. No, just kidding. Burns said, Richard – if inflation is increasing you have to reduce spending. If unemployment is increasing you have to increase spending. Richard wasn’t dumb so he asked Burns what happens if inflation and unemployment were both rising. Burns put down his stogie, peered out the window and said, Richard I suggest you find another job. We don’t have any theory about what to do in that situation. Richard then discussed the matter with several hanging portraits and came up with a brilliant solution. He would out-do the Soviets. He would control every price and wage in the USA. It makes sense, right? If prices and wages are rising too fast, then just put a lid on them. He could ask Burns to juice up the money supply and increase spending while at the same time telling workers and firms he would cut off their heads if they raised prices.

Nixon imposed the Wage and Price Controls starting in August of 1971 and finally ended them in 1974 after almost destroying the US economy. Nixon didn’t count on several things – I guess that is what you call the law of unintended consequences. For one thing, businesses mostly found ways to get around the controls. As usual, the bright folks get by just fine. For example candy producers discovered if you made the candy bar smaller they could raise price per ounce even though the price of the bar remained the same. So we mostly ate smaller candy bars and drove in lower quality cars. The price index showed no change but we were definitely paying more for the things we wanted. Second, as OPEC was starting to flex its muscles, Nixon realized there was little his controls could do to stop the impending impacts on prices of oil and food prices. Yes food, the ugly cousin of energy, had also raised his pimply head as droughts and other calamities had cattlemen shooting their herds because they couldn’t afford to feed them. They did not shoot their teenage kids thankfully because there were laws against that. As a result the never successful W&P controls started making exceptions and were never the same again. Of course since Nixon was also the clever guy who ended the Gold Exchange Standard, he had to deal with the effects of a declining dollar on the cost of QE2 Transatlantic cruises and a variety of other things US citizens wanted to buy from abroad at rising prices.

Hindsight is fun isn’t it? The lesson in this case is that since policymakers were confused about the economy they started doing new and crazy things. The crazy things probably made the economy worse instead of better. It is no accident that both inflation and unemployment increased in the mid-70s and then again in the late 1970s. Nothing Nixon, Ford, or Carter did had much impact. At least nothing they did had much impact until they actually did the right thing. Carter gets some credit as does Paul Volcker, in that regard.

The right thing is just sticking with basic common sense. One had to be high on their drug of choice to not see in 1970 that the US economy was suffering from rapid growth in spending. You don’t need supply-side gurus to know, even in 1970, that the aftermath of too much government and private spending would be inflation followed by rising business costs. Recall the Vietnam War and the War on Poverty? Inflation was just about zero when the 1960s started but it predictably increased through the decade as it became clear that aggregate demand was lurching ever higher as buyers and sellers began to incorporate higher inflation expectations into their spending and wage behavior.

 It is too bad that we waited so long to do the right thing in the 1970s. It’s like deciding to lose weight only after you doubled your hulk. Things might have gone a little easier if you started to attack that mound of frivolous flesh after about a 10% gain. Anyway, it took until the end of the 1970s before Carter started to tighten the government budget and Paul Volcker raised interest rates to over 20%. That was no fun. But the diet eventually worked. Reagan then discovered supply-side economics after a hot weekend with the gorgeous Maggi Thatcher and that helped to address the problems with the cost side. Viola – tight money with some attention to supply side led to more stability in the next decade.

If we learn from history my guess is once again we won’t do the right thing. Our Washington folks will embrace some lame but popular excuse for a policy and we will live the next five years with all the unintended consequences. I am happy that the President and Congress are on furlough. If they would just stay there until November 2012 we might all be better for it. Doing nothing will look good compared to the novel and fun programs they are about to unfold.