THIS BOOK examines essential lessons learned from economic policies that were tried and that failed in the 1970s and reversed with success in the 1980s. We focus on government interventions into wage and price setting in the private economy—guideposts, freezes, controls, and so on—but we show that the same lessons apply to other government interventions and in other time periods, including the present.
The book starts in chapter 1 with a debate between economists Milton Friedman and Robert Solow in 1962 about the use of wage and price guideposts as a tool of government policy. Those 1960s guideposts were the precursor of outright price and wage freezes and controls in the 1970s. Friedman argued against the wage and price guideposts and Solow argued in favor of them. Verbatim quotes from the debate show how two brilliant economists can be diametrically opposed about a major policy because of differences of view in how the economy works. Eventually, the debate led to major changes in the way economists model the overall economy, largely as Friedman suggested—although, as we show in later retrospectives by the two economists, the disagreements did not go away.
Chapter 2 shows how the guidepost policy of the 1960s expanded into wage and price control policy in the 1970s, starting with a freeze in 1971. Again, views about how the economy worked featured prominently in the policy decision. In a 1971 memo newly unearthed in the Hoover Archives (included as appendix B), Arthur Burns, economic adviser to President Nixon and chair of the Federal Reserve Board, argued in a letter to the president, marked “personal and confidential,” that the private economy had changed: it now needed government interventions into private-sector wage and price decisions if it were to experience low inflation and low unemployment. Burns did not think the Fed’s traditional monetary policy tools could do the job, so he advocated for government controls on wages and prices—and he won the argument. Though many then thought of Burns as being essentially infallible, the chapter opening, which describes a White House engagement with George Shultz, shows that he was not so infallible after all.
Chapter 3 delves into the costs of the wage and price controls as enacted in practice. Although the controls were popular at first, the Federal Reserve under Burns began to increase money growth, and inflation rose. So controls were reimposed in 1973. By this time, a complex bureaucratic apparatus had been created to monitor and administer prices, and the system had become a drag on the economy, as Friedman had predicted. Shultz resigned as secretary of the Treasury in 1974 in protest, but the damage continued into the Ford administration with more failed and unorthodox inflation-control policies—such as the “Whip Inflation Now” buttons—and on through the rest of the 1970s as described by John Taylor, who worked at the Council of Economic Advisers during this period.
Chapter 4 describes the reversal of the policy and the end of the controls. In a 1974 speech, Friedman contrasts the costs of the interventionist wage and price controls with the benefits of the noninterventionist move toward flexible exchange rates that he showed was due to Shultz’s leadership as secretary of the Treasury. How much better would the economy have been, Friedman asked, if that market-oriented approach had been followed in the domestic economy?
But it was not until the start of the Reagan administration that all the controls were removed, including those on energy, and the guideposts were ended. The end of price controls and the support for sound monetary policy were central elements of a set of recommendations contained in a memo (included as appendix C) to President-elect Reagan from economists who had advised him in the campaign. By this time, Paul Volcker was chair of the Federal Reserve Board. He began to introduce a sound monetary policy to reduce inflation, essentially reversing the inflationary trajectory started under Burns. There was no need for interventionist wage and price controls when these tried-and-true methods were in place. The chapter ends as it began, with a crystal-clear analysis from Friedman expressed in a later interview. He contrasts the approaches used under President Nixon in the 1970s, when Burns was Fed chair, with the policy approach under President Reagan in the 1980s, with Volcker as Fed chair.
Chapter 5 draws the main lesson from this important era in US history. The evidence shows that tried-and-true economic policy works and that, however tempting at any given time, deviating from such policy doesn’t. The starting point for deviation is often a new view of how the economy works, which calls for a different policy approach, but which proves wrong too late, with lasting damage. The needed policy reversal is often difficult, because views get entrenched, but the eventual improved performance is usually convincing.
In our experience in government, Shultz’s mainly in the 1970s and 1980s and Taylor’s mainly in the 1990s and 2000s, this dynamic sequence is common in all areas of economic policy making, not simply wage and price controls. The breadth is reflected in the comprehensive set of reforms—tax, regulatory, budget, monetary—listed in the 1980s policy memo in appendix C. Moreover, in our experience, the policy cycle is recurring: similar stories are found in recent years, from the 1990s to the present. It requires vigilance on the part of policy makers and an insistence on a robust, open analytical approach in order to avoid costly deviations from good economic policy making. In other words, let’s examine this little piece of economic history and see what it teaches us about future economic policy.