Year to June, the consumer price index rose 9.1%, “the largest 12-month increase since the period ending in November 1981.” During that time, the rate declined from a peak of 14.6% in March and April 1980 and would fall to 2.3% in July 1983. What caused this inflation? How slow was it?

In the 1960s, monetary policy was based on a concept called the Phillips Curve. It held that there is an inverse relationship between inflation and unemployment so that as one rises, the other falls. Policymakers can buy lower unemployment at the price of higher inflation and vice versa.

This relationship broke down in the late 1960s. Inflation rose from 1.6% in 1965 to 5.9% in 1970 but unemployment also rose, from 3.5% in 1969 to 6.0% in 1971. Federal Reserve Chairman Arthur Barnes complained:

“The rules of the economy are not working like they used to. Despite the widespread unemployment in our country, the rate of wage growth has not slowed down. Despite much slack industrial capacity, commodity prices continue to rise rapidly.”

In 1971, President Nixon imposed wage and price controls but inflation continued to rise. In 1974 the CPI rose to 11.0% and President Ford launched the ‘Whip Inflation Now’ – WIN – campaign, the most memorable element of which was wearing a ‘WIN’ badge. And unemployment continued to rise, hitting 8.5% in 1975. In 1978, with inflation at 7.6%, President Carter said:

“Inflation is clearly a serious problem. What is the solution? I don’t have all the answers. No one does. Perhaps there is no complete and adequate answer.”

This was not entirely true. Anna J. Based on his monumental study with Schwartz, A Financial History of the United States, 1867-1960Economist Milton Friedman – who exposed the fallacy of the Phillips curve in 1968 – has long argued that:

“Inflation is always and everywhere a monetary phenomenon in the sense that it can only be produced by a more rapid increase in the quantity of money than in output.”

Friedman rejects popular inflation, especially fuel price hikes by “Arab sheikhs and OPEC”:

“They have imposed a heavy price on us. The sharp rise in oil prices reduced the amount of goods and services available for our consumption as we had to export abroad to pay for the oil. A decrease in output increases the price level. But that was a once-for-all effect. It did not create a lasting effect on the inflation rate from the higher price level.”

He contrasts the low inflation of Germany and Japan, which imported all their energy, with the high inflation of the United States, “which is only 50 percent dependent, or…the United Kingdom, which has become a major producer of oil.”

The key variable was monetary policy. Inflation was not an impenetrable mystery: it resulted from printing money at a rate greater than the expansion of the real economy. It follows that if you control the growth rate of the money supply, you can control inflation.

In July 1979, Carter appointed Paul Volcker as Fed Chair. He knew what he was getting into. In their first meeting, Volcker told the president, “You have to understand, if you hire me, I’m in favor of tougher policies. [his predecessor]”

Volker proved as good as his word. In October, he initiated a fundamental shift in Fed policy. Changes in the daily level of the Fed funds rate were “too low, too late to affect expectations,” Volcker recalled, adding, “We needed a new approach.”

“Simply put, we will control the quantity of money (money supply) rather than the price of money (interest rates). The widely quoted adage that inflation is a matter of ‘too much money chasing too few goods’ promises a clear, if oversimplified, rationale.”

Interest rates will fluctuate and rates will rise as money growth slows: three-month Treasury bill rates exceed 17%; Commercial bank prime-lending rates hit 21.5%; Mortgage rates are around 18%.

The consequences were brutal. Real GDP declined at an annual rate of 2.1% in the second quarter of 1980, and the unemployment rate rose from 5.6% in May 1979 to a peak of 10.8% in November and December 1982. To his credit, Carter, unlike his predecessors, did not pressure Volcker to loosen policy, even as he entered an election year. Ronald Reagan defeated him in a landslide.

Volcker once advised Nixon, “If you have to have a recession, do it early.” Reagan did and reaped the rewards. Real GDP growth was 7.2% in 1984, inflation was 1.9% in 1986, and unemployment fell to 5.3% in 1989. ‘It was morning in America,’ Reagan said, ‘and he was reelected in a landslide.

Then, like now, ‘It’s the money supply, stupid.’


John Phelan is an economist at the Center for the American Experiment.

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