The Great Inflation and Its Aftermath: The Past and Future of American Affluence

When unemployment was too high, government could stimulate spending and production. It would cut taxes, increase federal spending—even plan a deficit—and reduce interest rates. This was essentially sophisticated “pump priming.” If too much priming aggravated inflation—pushing up prices because demand was greater than supply—then the process could be reversed. Taxes and interest rates could be raised; federal spending could be cut; the budget could swing to surplus. The economy would slow; inflation would subside. This sort of “activist economics” cast economists as public-spirited engineers who could deliver everlasting prosperity. Not coincidentally, their power and prestige would ascend. “Fine-tuning” is what this approach was ultimately called. Some of the Kennedy-Johnson economists later complained that the label was a journalistic simplification and exaggeration. Not so. In 1965, President Johnson—no doubt reading words that his economists had written or approved—declared, “I do not believe that recessions are inevitable.” As late as 1970, Arthur Okun, a Yale economist who served on Johnson’s CEA from 1964 to 1969 (with a year as chairman) wrote, “Recessions are now considered to be fundamentally preventable, like airplane crashes and unlike hurricanes.”

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When inflation inevitably worsened, the Fed reacted—acknowledging that it had left the highway—by tightening money and credit. Slowdowns or recessions (those of 1966, 1969–70 and 1973–75) ensued. But unfailingly, these responses were inadequate, because (as Burns noted) they were abandoned too quickly. Inflation abated briefly, and then the errors were repeated.

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Shoe prices went up, so LBJ slapped export controls on hides to increase the supply of leather. Reports that color television sets would sell at high prices came across the wire. Johnson told me to ask RCA’s David Sarnoff [RCA was then a major TV manufacturer] to hold them down. Domestic lamb prices rose. LBJ directed [Defense Secretary Robert] McNamara to buy cheaper lamb from New Zealand for the troops in Vietnam. The President told CEA [Council of Economic Advisers] and me to move on household appliances, paper cartons, newsprint, men’s underwear, women’s hosiery, glass containers, cellulose, [and] air conditioners.… When egg prices rose in the spring of 1966 and Agriculture Secretary Orville Freeman told him that not much could be done, Johnson had the Surgeon General issue alerts as to the hazards of cholesterol in eggs.18

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Because the unemployed soon expected to be rehired, their wage demands didn’t decline. Companies stuck with surplus inventories were “less likely to cut prices to clear the shelves—as they once did. Experience has taught them that, in all probability, demand will turn up again.” Government intervention was needed to break the spiral.20

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There was another lesson, too: To succeed against entrenched inflation, policies had to be harsh. The credit controls, like the earlier incomes policies, were supposed to make anti-inflationary policies work without hurting. Controls would simply choke off inflationary credit. No one would really suffer. This was a delusion.

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Globalization required a strong America, and a strong America required that inflation be subdued. As a result, capitalism’s prestige increased, and the dollar was restored as a dependable currency for trade and international finance. The persistence of higher inflation would have stunted globalization.15

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The strategy succeeded. From 1950 to 1970, world trade grew roughly by a factor of five. Tariffs dropped dramatically. Before the war, U.S. tariffs averaged about 50 percent; now they’re less than 5 percent. But this initial globalization need not have continued. By the late 1970s, rampaging inflation had weakened the U.S. economy and eroded American leadership. We can never know exactly what would have occurred if the erosion had continued, but we can speculate.

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People now forget that in the 1970s the economy was becoming more inflation-prone, unstable and subject to rising unemployment. These developments were wildly unpopular. American firms were also less capable of generating higher living standards, even as they were losing markets to German, Japanese and other foreign companies. The old order was not, as popular lore now holds, deliberately discarded. Instead, it slowly succumbed under the weight of its own failures.

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Its economic illusion—which explains its powerful, nostalgic appeal—was that we could create a virtually utopian system that would marry all the advantages of an expanding economy (more jobs, technological advances, new products, higher living standards, and more personal choices) with all the advantages of a static economy (greater job security, more certainty, familiar technologies and business methods), without suffering the disadvantages of either. The central contradiction was that an economic system premised on change could simultaneously banish change. We would enjoy the gains and avoid the pain. The fact that the ideal seemed to have been realized briefly in the late 1960s, when American companies dominated the world and the U.S. economy was in the midst of a fabulous boom, created the myth—still cherished by some—that the old order was a practical possibility. In fact, this temporary triumph was mostly the result of the first intoxicating phase of inflationary economic policies (which created the initial boom) and the lingering aftereffects of World War II (which eliminated most international competition). In the 1970s, both these props collapsed.

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The new economic order was indeed inferior to the imagined and romanticized version of the old order. But it was superior to the old order as it actually operated. Still, the new order’s defining characteristics consisted of a series of paradoxes. Consider: First: Although the economy became more stable—with fewer and milder recessions—individual workers and companies faced more insecurities and uncertainties about jobs, wages, fringe benefits and the very survival of firms.

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Lifestyle changes such as these—well-educated people marrying one another, people living longer or divorcing—explained at least as much about widening income inequality as wage differences did. In one study, economist Chulhee Lee attributed three-quarters of the increase of inequality from 1968 to 2000 to broad social changes. Married couples, most with two earners, dominated the richest fifth of families; in the poorest fifth, less than half were married and a third of heads—presumably old, disabled, unskilled or unmotivated—had no job. Studying the shorter period of 1979 to 2004, economist Gary Burtless of the Brookings Institution came to a similar conclusion, though he attributed only half the increase of inequality to social trends. To some extent, income gains were also understated, because more and more of pay was diverted to employer-paid health insurance. By one estimate 35 percent of the increase in average compensation for full-time workers from 2000 to 2005 went to health benefits.17

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Finally, it’s worth noting that most of the poor aren’t poor because the rich are rich. Family breakdown, low skills, bad work habits, poor health and bad luck are more likely causes. If the rich were poorer—and the market redistributed some of their income—the likely gainers would be the near-rich, today’s upper-middle class.

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From 1960 to 2005, the annual growth of the economy (Gross Domestic Product) averaged 3.4 percent, with contributions from labor force and productivity growth varying in different periods. Averaged over the entire span, productivity rose 1.9 percent annually and working hours 1.5 percent. By the mid-2020s, the Social Security Administration expects economic growth to slow to about 2 percent annually. Labor force growth would be scant (about 0.3 percent annually), as new workers barely offset retirees; productivity growth (1.7 percent

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