In memory of Jimmy Carter, who didn’t cause the 1970s inflation

But he should get credit for stopping it

I heard a recent summary of Jimmy Carter’s record as President that included the claim that he was responsible in some way for the acceleration of inflation in the 1970s. This was presented as a known fact—but it’s simply wrong. He gets blamed for creating an inflationary episode that started before his term, and that the US would have experienced regardless of who was President from 1977-1981. Yet, Carter’s key contribution to the 1980s disinflation, the solution to the problem, is too often overlooked.

Where did 70s inflation come from?

Economists tell two stories about the origin of the inflation of the late 1970s. Neither depends on Carter. In fact, both predate Carter’s election.

The first story is that the Johnson administration attempted to have it all in the 1960s: guns and butter in the famous phrase, expensive domestic reforms along with an expensive war. Demand for goods and services consequently pushed past the economy’s ability to produce in 1966-68, and inflation accelerated. That created expectations for future inflation that were hard to tamp down, and left policymakers in the 1970s with unpleasant choices.

The second story is that oil prices started moving up in the early 1970s, and then were given a huge push by OPEC in 1973. The resulting energy shock created an inflationary environment: the Fed didn’t react strongly enough to the inflation.

In both cases, the story depends on the initial shock locking in higher expectations for future inflation, and creating a higher underlying rate of inflation that was impossible for policymakers to manage.

By 1977, when Carter took office, the underlying inflation rate was pretty high. From the 1974 peak of 10%, inflation had come down to only 5.6% in 1976, which people at the time deemed unacceptable (as we would today).

But the unemployment rate was even more unacceptable. In 1977, it averaged 7.1%, down from the 1975 rate of 8.5%, but still the primary problem for economic policy.

The Johnson-Nixon-Ford record of mismanagement

The truth is that Carter inherited an economy that had been badly mismanaged. First, Johnson attempted to have it all. Second, Richard Nixon, on taking office, understood inflation to be a demand side problem, and attempted to cut government spending. At the same time, the Fed, faced with inflation, tightened monetary policy. Not surprisingly, the economy went into recession in late 1969. Inflation remained high as the unemployment rate rose (“stagflation”), which (contrary to the belief of many) was something many economists thought might happen temporarily. But the “temporary” period looked like it might coincide with the coming election. So Nixon then became concerned about the state of the economy. His administration’s response was in some respects very helpful, but mostly set the economy up for future trouble. Nixon took three major actions:

1. He took the US off the gold standard. While this created a certain amount of chaos initially in international financial markets, it turned out to be the right decision for the long run. Today, we take the system of floating exchange rates created by Nixon’s decision for granted.

2. He instituted Wage and Price controls to cut inflation. These worked about as well as any economist might expect, which is to say they created hidden price increases, and, over time, a growing number of market dislocations. Certain items (this author remembers beef) disappeared from markets as the price mechanism was unable to create equilibrium. Although the administration gradually removed most of these controls, controls on key key commodities (“Phase III”) remained in place in 1973. Gasoline was one of those key commodities. So when the oil price quadrupled in late 1973, gasoline shortages appeared. The “Phase III” controls were the direct cause of the gasoline lines that people so hated in 1973 and 1974.

3. Finally, Nixon pressured the Federal reserve to loosen monetary policy before the 1972 election. (See here https://www.aeaweb.org/articles?id=10.1257/jep.20.4.177). Whether the Fed reacted inappropriately remains an open question. But whether Arthur Burns was really trying to ensure Nixon’s (and then Ford’s) reelection, or simply following then-consensus economics, the truth is that the Fed released the brakes—try to slow inflation by slowing the economy and letting unempoyment rise seemed a bad bargain to policymakers at the time.

All of this led to a back and forth of Fed policy that reduced confidence in its ability to manage inflation—precisely the confidence that contemporary economists view as the most important asset of an effective central bank.

In his short stint as Nixon’s replacement, Gerald Ford didn’t do much to change things. He didn’t take any actions to help improve Fed credibility or to explain the difficult choices facing Americans at that point. Instead, his most well-known policy was the creation and distribution of pins imprinted with “WIN” for “Whip Inflation Now.” (I am a bit unfair here, Ford had a number of more substatial ideas. But, in retrospect, he didn’t get anywhere trying to apply them, and they didn’t address the underlying issue.)

Ford’s hapless attempts to address the problem suggest that a counterfactual world in which Ford won the 1976 election would hardly bought the country lower inflation in the late 1970s. In fact, the US might have experienced even higher inflation, since it was Ford’s successor—that’s right, Jimmy Carter—who finally took the drastic action necessary to set the country onto a path for lower inflation.

Bad advice from economists

To be clear: these actions happened over a period of time when the consensus in economics about how to manage the economy was deeply flawed. Some left of center economists applauded Nixon’s price control scheme (for example, see here) because they dismissed the importance of monetary policy in determining inflation. And many economists believed that inflation was relatively benign compared to the alternative. Not just on the left: Milton Friedman and Anna Schwartz had only recently published their comprehensive history of monetary policy in the United States. That book documented how fear of inflation had led the Federal Reserve to create a global liquidity crisis in the early 1930s, deepening the Great Depression around the world. Although Friedman himself in fact didn’t apply this lesson in the early 1970s, and was a proponent of tighter monetary policy—the approach that did, in the end work to reduce expectations and put inflation on a downward path.

Carter’s world was one where many economists agreed that there was a permanent tradeoff between inflation and unemployment. Today the professional consensus is that this tradeoff exists only in the short run. As a result, economists were much more willing then to suggest that the benefits of lower unemployment were worth the cost of higher inflation. Many of the economic advisors to presidents during the 1960s and 1970s, as well as much of the staff at the Federal Reserve and Treasury, held those views. Johnson, Nixon, Ford, and Carter certainly got plenty of bad advice.

President Ford would not necessarily have done any better

Carter, then, inherited a mismanaged economy, with a relatively high rate of inflation and a high unemployment rate. And his advisors told him that inflation was an acceptable price for letting the unemployment rate fall. Whether Carter had any choice in the evolution of the economy over the next couple of years is questionable. But the unemployment did in fact fall, although too slowly: by 1978 the unemployment rate was 6.1%, still considerably above the level most economists at the time thought was consistent with “full employment.” However, just about every potential leader of the US at that time would have preferred a falling unemployment rate to the alternative of lower inflation with a rising unemployment rate. It’s hard to believe that a President Gerald Ford or a even a President Ronald Reagan (who contested the 1976 Republican Presidential primaries) would have done anything differently. In any event, the President’s actions probably had little to do with the inflation and unemployment rate outcomes for the first few years of his term.

In 1979, inflation started accelerating again. The immediate cause was the Iranian revolution, which shook up the global oil market. The remnants of those Phase III price controls create more gas lines: and President Carter would have done better to have jettisoned the legacy of Nixon’s ill-conceived policy. This was certainly an error.

But the real problem wasn’t just the spike in oil prices. It was that fact that Americans—workers, businesses, and consumers—now believed that high inflation was here to stay. And as they built on those beliefs (a legacy, really of the Johnson-Nixon-Ford inflation debacle), each shock would just send the underlying rate of inflation higher. How to reduce those expectations and the underlying rate of inflation?

Carter’s Courage

Carter’s response was, in every sense of the word, courageous. He jettisoned the advice of his traditional macroeconomic advisors. Given the ability to choose a new Fed chair, he chose one (Paul Volcker) who proposed a difficult but ultimately successful approach to inflation: slow the economy to convince Americans that inflation was not the new permanent state. That was harder than anybody expected: it took back to back recessions to do it. But that approach did, in fact put inflation on a downward path.

I believe that Carter understood that he was asking the American people to undergo pain in the short run to achieve an improved economy in the longer term. But he was never able to explain this. Possibly because it wasn’t a message Americans wanted to hear. And I believe that Carter sacrificed his presidency for that lower inflation, a sacrifice too few Americans realize that he made.

Of course, Carter didn’t intend to sacrifice his presidency. But he knew there were risks in the approach. And he even saw, in the first half of 1980, that the initial result was a spike in unemployment. But he continued to support Paul Volcker’s disinflation strategy, knowing (as he must have) that it was making his political life harder. That’s an impressive feat for a politician at any time.

Carter’s successor, Ronald Reagan, should get credit for continuing to support Volcker through the 1982 recession, which was indeed brutal. And which had difficult consequences for the Republican party. But by 1984, the economy was recovering, inflation was falling, and Reagan was able to campaign on the slogan “It’s morning in America.” Reagan himself never underwent the ultimate test of whether he would have supported such an unpopular, but correct, policy at the expense of his own career.

The truth is that Jimmy Carter was in no way responsible for the inflation that he had to manage. He inherited it from his predecessors. They left him a difficult choice. And he ultimately chose well, creating conditions for longer term growth and prosperity in the United States. It’s time that his achievements in making macroeconomic policy stand beside his other achievements: successful deregulation in transportation industries, improving the climate for international trade, stressing the importance of human rights in foreign policy, and negotiating the peace treaty between Israel and Egypt. For a one-term President, Jimmy Carter might have been one of the most successful Presidents of the post World War II era.