There was no deficit problem: government debt was low and stable or falling as a share of GDP during the 70s. Rising welfare rolls may have been a big political problem, but a runaway welfare state more broadly just wasn’t an issue — hey, these days right-wingers complaining about a nation of takers tend to use the low-dependency 70s as a baseline.He points out that the solution actually adopted - high interest rates imposed by Fed Chairman Paul Volcker which began under President Carter, who appointed him, and the deregulation and (domestic) austerity - didn't have completely admirable results, to put it mildly. "It worked on the inflation front, although some of the other myths about all that are just as false as the myths about the 1970s. No, America didn’t return to vigorous productivity growth — that didn’t happen until the mid-1990s."
What we did have was a wage-price spiral: workers demanding large wage increases (those were the days when workers actually could make demands) because they expected lots of inflation, firms raising prices because of rising costs, all exacerbated by big oil shocks. It was mainly a case of self-fulfilling expectations, and the problem was to break the cycle.
So why did we need a terrible recession? Not to pay for our past sins, but simply as a way to cool the action. Someone — I’m pretty sure it was Martin Baily — described the inflation problem as being like what happens when everyone at a football game stands up to see the action better, and the result is that everyone is uncomfortable but nobody actually gets a better view. And the recession was, in effect, stopping the game until everyone was seated again.
Even Krugman is conventional enough to sidestep the Galbraithian option of wage and price controls as a tool to deal with the inflation of that time. Instead, he winds up giving a rather fatalistic picture of the options of the time:
Was there a better way? Ideally, we should have been able to get all the relevant parties in a room and say, look, this inflation has to stop; you workers, reduce your wage demands, you businesses, cancel your price increases, and for our part, we agree to stop printing money so the whole thing is over. That way, you’d get price stability without the recession. And in some small, cohesive countries that is more or less what happened. (Check out the Israeli stabilization of 1985).People eagerly interpret the past in light of the present and often do so superficially. But it is important to try to remember what really happened.
But America wasn't like that, and the decision was made to do it the hard, brutal way. This was not a policy triumph! It was, in a way, a confession of despair.
Tags: paul krugman, stagflation, us economy