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How the Fed Learned to Stop Worrying and Love Easy Money

Mises Daily: Saturday, November 02, 2013 by Joseph T. Salerno (http://mises.org/daily/author/237/Joseph-TSalerno)

In this selection from chapter 19 of Reassessing the Presidency (newly available as an ebook (https://mises.org/store/Reassessing-the-Presidency-TheRise-of-the-Executive-State-and-the-Decline-of-FreedomDigital-Book-P10928.aspx) from the Mises Store), Joseph Salerno examines one example of how the Federal Reserve and U.S. presidents work together to expand the size and scope of government.

... It w as not ultimately budget deficits that allowed Kennedy to initiate the corporatist planning and militarization of the U.S. economy that bore first fruit in the emergence of the American welfarewarfare state during Johnsons Great Society and culminated in Nixons fascist New Economic Policy. The policy that facilitated Johnsons simultaneous financing of extravagant expenditures on w elfare programs and the military adventure in Vietnam and made conditions ripe for Nixon's imposition of wage and price controls was not newfangled functional finance but old-fashioned monetary inflation. As the historian of macroeconomic policy, Kenneth Weiher, has pointed out, it was not the muchvaunted fiscal revolution but the ov erlooked monetary revolution that took place during the Kennedy administration which turned out to be the predominant influence on the economic events of the 1960s and 1970s. As Weiher stated: There was a revolution all right, but the most important change occurred at the Federal Reserve; how ever, 10 years passed before more than a handful of people caught on to what was happening. In the three years of the Kennedy administration the growth of the money supply as measured by M2 av eraged about 8 percent per year. If we take the eleven prior years going back to 1950, the rate of growth of M2 av eraged 3.6 percent per year; if we go back four more years, to the first postwar year of 1946, the av erage annual rate of M2 growth over the fifteen-year period drops to 3.3 percent. There were basically tw o reasons why the role of monetary policy tended to be so grossly underplayed in the economic histories of this period. The first was that the new economists themselves, as unreconstructed Keynesians, uniformly denigrated the potency of monetary policy while touting the effectiveness of fiscal policy. Thus the Kennedy tax-cut bill, which did not even take effect until 1964, receives the lions share of the credit for stimulating the recovery from the 1960-1961 recession. Second, because most economists since the 1930s, including and especially those of Keynesian orientation, identified inflation with increases in the price level, and interpreted the 1.2-percent average annual rate of increase of the CPI during the period 1961-1963 as ev idence of the absence of inflation ... Despite the negligible increase in the CPI, however, the effects of the rapid, and initially unanticipated, monetary inflation were visible in credit markets as real interest rates trended steadily
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dow nward throughout the decade. Unfortunately, both Keynesian and central bank orthodoxies of the 1960s focused on the nominal interest rate as an important indicator of the degree of ease or restraint of monetary policy, making no allowance for the effect of inflationary expectations on the nominal interest rate. Consequently, neither the new economists

nor the monetary authorities believed that monetary policy was unduly expansionary because short-term nominal interest rates rose from 1961 to 1963. Indeed, the new economists were quite pleased with monetary policy during this period, an attitude typified in Seymour Harriss observation that the [Federal Reserve] board prov ided the country with a reasonably easy money policy ... Giv en that monetary policy w as indeed grossly inflationary during the Kennedy years, what accounts for the sudden and radical shift in Federal Reserve policy from the moderate inflationism under the Eisenhow er administration? The answer is Kennedy and his new economists, who conducted a relentless and incessant campaign for easy money from the very beginning of his administration. This campaign took the form of repeated public utterances on the part of the president and his economic adv isers, as well as direct presidential pressure on William McChesney Martin, who was chairman of the Fed under Eisenhower and continued in that position until 1970. Kennedy and key members of his administration also doggedly prodded the Fed, both publicly and privately, to ease monetary policy, ev en threatening to terminate its independent status if it did not acquiesce. As early as his campaign for the presidency, Kennedy expressed his disappointment with the Feds tendency to resort to restrictive monetary policy to rein in inflation and his intention to break with such a policy. In April 1962, Kennedy petitioned Congress for a rev ision of the terms of the Fed chairmanship that would enable each president to nominate a new chairman at the beginning of his term. Heller, Treasury Secretary Dillon, and Treasury Undersecretary Roosa also w eighed in with calls for the Fed to ease monetary policy. Despite some initial foot-dragging and repeated cav eats that the Fed would only finance real economic grow th and not budget deficits, Fed Chairman Martin ultimately capitulated to the insistent demands of Kennedy and the new economists for a cheap-money policy. In fact, in February 1961, the Fed abandoned its long-standing bills-only doctrine, which dictated that open market operations be conducted exclusively in the market for short-term securities. In doing so, the Fed was accommodating the administrations request to reduce long-term interest rates by buying long-term securities while simultaneously selling short-term securities in order to nudge up short-term interest rates. This attempt to artificially twist the interest-rate structure nicknamed Operation Tw ist was devised by the new economists to accomplish tw o goals: to stimulate domestic business investment and new housing purchases and to discourage the outflow of domestic and encourage the inflow of foreign short-term capital as a means of mitigating the U.S. balance-of-payments deficit. Needless to say, this attempt to have ones cake and eat it too to pursue a domestic cheap money policy and to avoid its adv erse consequences for the balance of payments was a failure ... Our conclusion then is that Kennedy and the new economists succeeded in w ringing from the Fed precisely the inflationary monetary policy they desired and that this policy represented a radical break with the monetary policy pursued in the 1950s. This conclusion, which is certainly reflected in the money-supply growth rates cited above, also accords with the perceptions of the new economists themselves. Seymour Harris, long-time Kennedy economic adviser and chief academic consultant to the Kennedy Treasury, made this pellucidly clear in his book on the economic policies of the Kennedy years. Harris concluded that:

In short, monetary policy under Kennedy was much more expansionist than under Eisenhow er. ... Federal Reserve policy in 1961-1963 was not like that of 1952-1960. At the early stages of recovery in the 1950s, the Federal Reserve, overly sensitive to inflationary dangers, aborted recoveries. W hether the explanation was the grow ing conviction that inflation was no longer a threat, or whether it was an awareness that the Kennedy administration would not tolerate stifling monetary policies, the Federal Reserve made no serious attempts to deflate the economy after 1960. In fact, in 1963 Mr. Martin boasted of the large contributions made to expansion ...

Thus, inflationary monetary policy was the sine qua non for the regime of permanent budget deficits that was initiated in the early 1960s and continued uninterrupted almost to the end of the tw entieth century. That priv ate investment was able to continually expand concurrently w ith sharply increasing gov ernment spending on military and other programs was attributable in large measure to the fact that, during the Kennedy years, the Fed was induced to cooperate by routinely monetizing the cumulating budget deficits necessary to finance these programs.

Note: The views expressed in Daily Articles on Mises.org are not necessarily those of the Mises Institute. Comment on this article. Joseph Salerno is academic v ice president of the Mises Institute, professor of economics at Pace University, and editor of the Quarterly Journal of Austrian Economics (ht tp:// mises .org/ qjaedispla y.asp) . He has been interview ed in the Austrian Economics Newsletter (http://mises.o rg/jo urnals/aen/aen1 6_3_1 .asp) and on Mises.org (ht tp:// mises .org/ daily /321& month=13) . Send him mail (mailto:salerno@mises.com). See Joseph T. Salerno's article archives (http://mis es.or g/daily/author/ 237/Joseph-T-Sa lerno ) . You can subscribe to future articles by Joseph T. Salerno via this RSS feed (ht tp:// mises .org/ Feeds /articles.ashx?Autho rId=2 37) .
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joebhed (http://intensedebate.com/profiles/joebhed)

-56p 1 week ago

-16

Joe, WTF, this is the 3rd time. You provide another reference citation for how bad the government can be - this time the CB. But there is no causation provided, merely anecdortal criteria floating in policy space. It is said that the CB raised the interest rate throughout the period, but that M-2 grew by 8 percent. Wisdom pervades that an increase in the price of money results in a reduction in the supply of that same money. Would that the CB had lowered interest rates in hope of reducing the money supply growth? The overwhelming reality is that the CB is impotent when it comes to the 'monetary aggregates' that count in GDP and price inflation. The CB only impacts at M-ZERO which has ZERO impact on GDP and prices. Perhaps you can add something to the scholarship here by being clear on what the CB has done, and conversely, what they should have done differently. Truth be told, it is the bankers seeking rent that increases the money supply. Did they overshoot with the 8 percent growth? Maybe. But did government? Not sure. What was the correct policy action by government? Besides extinction, of course.
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1voluntaryist (http://intensedebate.com/people/1voluntaryist)

-57p 1 week ago +5

I guess we can rule out the theory that JFK was anti-Fed. The treasury issue of notes was probably just to prod the Fed into issuing, as in, "if you won't I will". Is this correct?
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Vanmind 1 week ago


Great stuff, professor Salerno, thanks.
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bhulihan (http://intensedebate.com/people/bhulihan)

64p 1 week ago

+3

Lets see, converting short term to long term, and going off bills only policy, in 1961? I thought Bernanke invented that. Does this mean we get price and wage controls from a Republican president in 2019?
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1 reply active 1 week ago +2

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Gamble 1 week ago


From Gambles Dictionary Define Statist Economy: Constant unjustified expansion of money base. See America 1913-present for example. Synonyms of Statist Economy: Command and Control, Socialism, Communism, tyranny. Antonym of Statist Economy: Free market Economy, Liberty, Peace.
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Gamble 1 week ago

Just read all of these Mises Quotes regarding inflation. If you still don't get it after reading these quotes it is because you don't want

to get it. You are a statist. You have forfeited your freedom. http://mises.org/quotes.aspx?action=subject&s... (http://mises.org/quotes.aspx?action=subject&subject=Inflation)
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El Tonno 1 week ago


Meanwhile, a boom in Silicon Valley: http://www.theregister.co.uk/2013/11/04/silicon_v... (http://w w w .theregister.co.uk/2013/11/04/silicon_valley_sheldons/)
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