Richard Drury
Carola Binder is an associate professor of civic leadership and economics at the University of Texas at Austin, and she is the author of a new book titled Shock Values: Prices and Inflation in American Democracy. Carola is also a returning guest to the podcast, and she rejoins David on Macro Musings to talk about this book and some recent work she has done on the Fed’s framework review. David and Carola specifically discuss the history of inflation in the US, the advantages of adopting a nominal GDP targeting regime, what to expect from the Fed’s upcoming framework review, and more.
Transcript
David Beckworth: It’s great to have you on, and last time you were on, Carola, you actually had the other side of the hot seat. You were interviewing me and Pat Horan on our paper, The Fate of FAIT, so that was a lot of fun. You also are a colleague of mine of sorts. You are a senior affiliated scholar with the Mercatus Center, and you visited us for a while during sabbatical, but it’s great to be talking to you again with the release of your new book, very exciting. So, Carola, last time we were together, you also were in Pennsylvania, (and) now you’re in Texas. You’re at UT Austin, so congratulations on that move, very exciting. Tell us about it and what you’re doing there.
Carola Binder: Sure, thanks. Yes, it is exciting. I recently have joined UT Austin in their new School of Civic Leadership. UT has a Civitas Institute, and now they’re going to have an actual school of civic leadership with a dean and faculty, and we are going to have faculty members who are economists, political scientists, and philosophers. There are going to be new minors and majors offered in PPE, which is politics, philosophy, and economics, and also in civic honors. So, I’m really excited about this new initiative and to be one of the founding faculty members of the new school.
Binder: I’m going to be teaching a class in the fall, for freshmen, called Inflation in American Democracy, which is the topic of my book, also. In the spring, I’ll teach a class on capitalism and democracy. So, there’s going to be more of an interdisciplinary focus than you’d have in just a regular economics department, but I will also have an affiliation with the economics department and get to go to their really great seminar series and work with some of the great economists who are there. They have a really good macroeconomics group.
Beckworth: That’s fantastic. Great program, great school, and great sports as well, right? You get to go to some big football games (and) basketball games as well and live in Austin, Texas, the capital of that large state.
Binder: That’s right.
Beckworth: I used to live near there, just south of there in San Marcos, Texas, many years ago. So, (it’s a) wonderful place, very warm right now, I understand. Is that right?
Binder: Yes, it’s very warm. We live south of Austin, and we inherited nine chickens. So, we’re really quite rural. We’re going to be doing a lot of gardening and raising these nine chickens.
Beckworth: Oh, that’s great. I know that you’ve got a family who will enjoy having those chickens around. So, Carola, something that you have been participating in is our Fed framework review that we’re doing here at the Mercatus, a series on that topic. As you know, it’s coming up here pretty soon. We have a number of authors (and) economists writing on this. And you wrote an essay for us that is titled, *Nominal GDP Targeting: Lessons from Recent History,* I believe that you’re one of the first essays that we’re going to release in this series. So, listeners, we’ll let you know when it is released, but tell us about your essay and what you are articulating in it.
*Nominal GDP Targeting: Lessons from Recent History*
Binder: So, my essay is about NGDP targeting, but the focus of the essay is whether recent years, the events of recent years, have made it a better or a worse time for adopting NGDP targeting now versus, say, a few years ago. A couple years ago, maybe in 2019, I gave a talk at Cato, at their annual monetary policy conference, arguing that it was a good time for trying to adopt NGDP targeting. I argued that the public would have been up for it at that time, (that) NGDP had been on a pretty stable path for a few years, and that it would be easier to convince people that stabilizing nominal income was a valuable objective rather than stabilizing inflation.
Binder: At the time, inflation had been quite low for many years, and it seemed like, just from a public opinion perspective, NGDP targeting would have been more acceptable. Then, in this brief, I wanted to say, well, okay, now we did get this burst of inflation, we had the pandemic and everything that happened in the last couple of years, so what has that done for the public opinion environment, and what did that mean for what people might think about adopting NGDP targeting or something like it? Well, really, everything we know about NGDP level targeting is basically theoretical.
Binder: We haven’t had an actual NGDP targeting regime to study, to know exactly how it would work in practice, but any kind of change in the monetary policy regime is going to require the political will to be there. So, to actually test out an NGDP targeting regime requires that you have some impetus to do it, and that the public is going to be accepting of it. So, I just wanted to think through, in my Mercatus brief, what aspects of the last couple of years would have increased the favorability of NGDP level targeting, and what would have decreased it?
Beckworth: Yes, so, what did you find and what are your conclusions?
Binder: I think that, on net, recent macroeconomic (capacity) has strengthened the case for NGDP level targeting, although it’s a balance. So, there are some ways in which NGDP targeting is still not going to be convincing to the public, but mostly, I think that recent experience does highlight the benefits of NGDP targeting and strengthens the case for adopting it. So, the first thing I talked about was just thinking about the path of NGDP during our two most recent recessions, and I think that if we think about both the Great Recession and the COVID pandemic, together they underscore the benefits of keeping nominal income growing steadily, and the costs of failing to do so.
Binder: So, in the Great Recession, NGDP fell below its pre-recession trend and stayed below trend for a long time, and we know that the Great Recession was associated with just a really slow recovery, that even when the recession was over, the labor market was still weak for many years, inflation was still below target, and, in general, it was just too slow of a recovery. Then, after the COVID recession, we had just the opposite. So, NGDP quickly rose back to its pre-recession trend path and then rose above it and kept above it as inflation rose a lot. So, we had this too-slow recovery, and then we had this overheated recovery.
Binder: Both of them came from not keeping NGDP, the path of NGDP, stable. So, I think that, together, they show two of the big macroeconomic policy mistakes in recent years came from not keeping the path of NGDP stable, and that maybe by keeping that path stable, we could have avoided those mistakes. So, I think that’s one way that you might be able to convince people that NGDP level targeting has a lot of merit. A second benefit of NGDP level targeting is the way that it lets monetary policymakers look through supply shocks, and the recent experience we’ve had really has demonstrated how important that is.
Binder: There were these big supply chain pressures during the pandemic, there were big geopolitical shocks, so we had high oil and commodity prices, and monetary policy is aggregate demand policy, and it can’t and shouldn’t offset supply shocks like those. So, when you have an NGDP level targeting policy, the nature of that is that you look through those supply shocks, which is optimal for monetary policymakers to do. If you had a really strict inflation targeting framework that required monetary policymakers to tighten even when there’s those adverse supply shocks, that would be highly destabilizing.
Binder: And I think that everyone saw that the Fed shouldn’t have tightened in response to those kinds of supply shocks during the pandemic. And so, that really just highlights that benefit of NGDP targeting. So, those are two of the benefits. Another one is one that you’ve talked about a lot, which is the informational advantages of NGDP level targeting. I think I even cite some of your work in this part of my brief, which is about how NGDP level targeting is really robust to our information problems we have, where monetary policymakers don’t actually know exactly what the so-called “stars” are, so, the natural rate of interest, the natural rate of employment, R-star and U-star.
Binder: You can do NGDP level targeting even without knowing exactly what those are. So, that really reduces the informational burden of conducting monetary policy. Now, that’s always an advantage of NGDP level targeting, but I think it becomes a bigger advantage when it’s harder to estimate those stars. When we’re in something like a pandemic, when there’s a lot of uncertainty, those stars become harder to estimate, making that benefit of NGDP level targeting itself bigger.
Binder: The last benefit that I talked about in the brief is also one that I think you talk about a lot in some of your writing and some of your paper about *The Fate of FAIT,* which is the asymmetry of the flexible average inflation targeting regime, which means that when inflation is below target for some time, then the Federal Reserve will try to offset that by allowing above-target inflation afterwards, but the Fed won’t make up for overshooting its inflation target.
Binder: So, I think that the recent high inflation episode that we experienced will probably have increased the public’s frustration with that asymmetry, because a lot of people are asking, “Why isn’t the Fed going to bring inflation down below 2%?” People are frustrated with just how high the price level is. Even as inflation is falling, the price level is still too high, and they’re just frustrated that we’re not going to have lower inflation to offset that high inflation. So, I think that that asymmetry of the FAIT framework is going to be a lot more questioned now that we’ve had the experience of the last two or three years.
Beckworth: Yes, those are all great points, and we look forward to releasing your policy brief. Let me go back and just ask a few questions on some of these issues that you raised. So, on the supply shock point, two comments, and then maybe you can give me some feedback on them. So, if you were to ask a central banker, someone who’s a mainstream New Keynesian model disciple of sorts, they would say, “Yes, we agree that we need to see through supply shocks and maybe some optimal monetary policy arrangement, we would do that.” I guess my pushback would be that it’s one thing to say that, (but) it’s another thing to actually be able to do that, or be empowered to do that, maybe to be disciplined to do it.
Beckworth: And I think that the pandemic experience illustrates this well, because in 2021, the Fed (and) all of us were still wrestling with, well, is inflation transitory or not? Is it caused by supply shocks or is demand driving it? And so, I guess my response to them would be, yes, it’s one thing to say that you will do the right thing and look through the supply shock, but it’s just very difficult in practice, unless you’re really bound by something like a nominal GDP level target. What are your thoughts on that?
NGDP Level Targeting: Looking Through Supply Shocks and Policy Communication
Binder: Right. I agree that discipline is really a big part of it, the discipline on the central bank, which also gives a lot of accountability and transparency. So, the central bank can always say, “Well, yes, we’re going to look through supply shocks,” but it’s hard to know when there’s a supply shock or not. If they say that we’re going to keep NGDP on this target path, then we can all see exactly what they’re trying to do, and what is guiding them, and how well they’re accomplishing what they’re setting out to do. And so, I think that it gives a lot of robustness there, where even if you don’t really observe what part is supply-driven (and) what part is demand-driven in real time, that by keeping NGDP on a stable path, it makes it easier for the central bank to behave as if they’re looking through those supply shocks even if they don’t see exactly what they are.
Beckworth: Right. We’re just trying to make life easier for the central bankers with a nominal GDP target. So, related to that, Jay Powell had a talk last November, I believe at the IMF, and he went through some of these points, and he said, “Look, it’s kind of like central bank dogma almost, that we are supposed to look through supply shocks,” and he said, “You know, that sounds great in theory, but in practice, it’s hard if you have a spate or a series of supply shocks, and you begin to worry about inflation expectations becoming unanchored.”
Beckworth: So, he goes, “I’m not so sure that we can always look through supply shocks.” Of course, my reply is, well, if you had a nominal anchor that allows you to look through supply shocks, you wouldn’t be losing inflation expectations. If you were anchored to something like nominal GDP level targeting, it’s the best of both worlds. You look through and don’t worry because you have this firm nominal anchor. Now, one last question on this policy of yours and then we’ll move on to your book, but one thing that Jay Powell has said about a nominal GDP level target is he’s – several times he says that he thinks it’s hard to communicate. It’s hard to sell to the public. How would you respond to him?
Binder: Well, a few years ago, I thought that it would actually be easier to sell it to the public, because inflation hadn’t been high in so long that people didn’t think of inflation as really a current problem and saying, “Look, we’re going to stabilize income,” was actually an easier sell, especially in a recession, where, often, in a recession, what the Fed is trying to do when they’re using expansionary monetary policy, (is) they’re trying to boost nominal income, which sounds good, (and then) saying that they’re also trying to boost inflation, which, to most people, sounds bad. Why would you try to raise inflation right when the economy is in a recession?
Binder: So, I thought that NGDP targeting was actually easier to communicate to the public. That, I think, might have changed a little bit, now that we’ve had this really high inflation episode. I think that that has made the issue of communicating an NGDP target harder, because especially if the Fed were right now to say, “Okay, we’re not going to target inflation, we’re going to target NGDP,” right when everyone said, “Oh, the Fed missed its inflation target,” (then) that would sound bad. It might sound opportunistic.
Binder: What I think the Fed would need to do is something like what you and Pat Horan discussed in your *Fate of FAIT* paper, which is just to modify the existing framework to make it more symmetric, which turns out to be quite similar to an NGDP level target. So, if you have flexible average inflation targeting, but it’s symmetric, and you’re making up for overshoots as well as undershoots, then you’re communicating to the public that you’re still going for 2% inflation, on average, over time. Then, the issue is explaining that, “Look, this is a way of achieving that goal that’s also going to have good properties for stabilizing the financial system and stabilizing the labor market, and it has this good transparency property, because you can easily predict what we’re trying to do and hold the Fed accountable for doing it or not.”
Beckworth: It will be interesting to see what the Fed does with this framework review, if they adopt something like that. I’m under no illusion that they’re going to go all out and say, “Hey, let’s do nominal GDP level targeting,” but they might make these small changes that push us in the direction. In fact, we just recently had on Jim Bullard, and he likes to say, “FAIT already is in the direction of something like nominal GDP level targeting, but there’s room for improvement.” So, hopefully, we’ll see something like that here, later this year. So, Carola, let’s switch over to your new amazing book. It is titled, Shock Values: Prices and Inflation in American Democracy. So, anything with shock in it must be shocking and awesome, so, great title, number one. Number two, tell us about the history of this book. How did you come about writing this book on the history of prices in America?
*Shock Values: Prices and Inflation in American Democracy*
Binder: Sure. Well, you can thank my editor at University of Chicago Press for the title. I was reluctant to have a shocking, catchy title like that. I just liked the “Prices and Inflation in American Democracy,” but he convinced me that we needed something catchier. So, yes, I started writing this book as inflation had started rising. I’ve studied inflation the whole time I’ve been an economist, so, about 10 or 15 years I’ve been studying inflation, but mostly that was during a time of low and pretty stable inflation.
Binder: I’ve written a lot of papers about how the public forms their expectations of inflation and some papers about the politics of central banking. But as inflation started rising, and I was reading the news about inflation all of the time, I started thinking a lot about the discourse in the media about our recent inflation episode. There was actually a piece in The Washington Post where they had, I think, 10 different economists give their opinion about what should be done about the high inflation.
Binder: Surprisingly, almost none of those said anything about monetary policy or the Federal Reserve. One of the opinions was actually that we should use price controls, and in that piece, price controls were described as a democratic solution to the inflation problem, and I thought that that was just kind of interesting and puzzling. What does that have to do with democracy? Why are we calling it a democratic solution? And as I was prodding into that, I realized that that was actually how President Roosevelt had described price controls. He had said that we needed this democratic solution to the wartime inflation.
Binder: I think that just got me thinking about the politics of price stabilization, not just the economics of it, but the politics, and even the legal and constitutional issues, and wanting to understand how, throughout US history, we have tried to stabilize prices, and how we’ve thought about the legitimate role of the government in doing that in American democracy. I couldn’t find any book that covered those issues the way that I wanted to see them covered, so I decided to write it myself.
Beckworth: Well, that is a great origin story. There’s a missing gap in the literature, and you jumped in to fill it, so, that’s great to hear. Give us, maybe, the executive summary, and then we’ll dive into each of the chapters.
Binder: Sure. So, it’s only really a recent part of American history, that we have price stability delegated to the central bank. Throughout US history, we’ve tried a variety of different approaches to price stabilization, including tariffs, regulatory policy – like price controls and other sorts of regulations – and various types of monetary policies, on and off of the gold standard. Every kind of episode of either inflation or deflation that the country has experienced has led to a lot of questions about, what is the legitimate role of the government in trying to stabilize prices?
Binder: And these kinds of questions have been debated in the public sphere, and often resulted in court cases. Well, another thing to add is that a lot of these major inflation episodes occurred during wartime, so they were always intermixed with issues about, what should the government do in an emergency? And there tended to be this expansion of powers during wartime emergencies that enabled the government to play a larger role in price stabilization, that didn’t always get fully removed after the emergency was over.
Beckworth: It’s interesting that your book came out when it did, given that we just went through this big inflation surge, and one of the things that we relearned is how much people dislike inflation, at least when it reaches a certain level. It’s very salient politically, and people really seem to care about it. You have several big themes throughout your book, and you outlined them early on. The first one is the disparate impacts of price fluctuations, and I’m wondering – looking across this sweep of history, (with) the reaction we saw in the past few years, people really dislike inflation. Is it present throughout US history? Because some of the examples – farmers, actually, they’re really upset about deflation. So, what is your sense?
The History of Inflation and Deflation in the US
Binder: Yes, so, that’s a really interesting question. I recently was the discussant for Stefanie Stantcheva’s paper, which is called, *Why Do We Dislike Inflation?* Which is a follow-up to a paper, by almost the same title, by Robert Shiller in 1997. One of the things that I mentioned in my discussion of her paper was that, “Well, sure, people on a survey now say that they dislike inflation, but if you look, during US history, what people really have disliked often is deflation,” and like you mentioned, farmers.
Binder: In a lot of US history, when most Americans were farmers, and farmers also tended to have nominal debts, deflation was really hard on them, because it increased the real value of their debt burdens. So, maybe the most famous would be William Jennings Bryan’s Cross of Gold speech, where he was arguing that we needed to leave the gold standard to be able to have monetary expansion to help the farmers, or to help the common man. So, this is like the populist take, that we need monetary expansion because what people are really hurt by is deflation, and what would help them is inflation.
Binder: There’s, I think, far more episodes of deflation becoming really unpopular. But also, the kinds of inflation that you would see, either during a war or during the Great Inflation, those were also really unpopular, but they led to this pretty big challenge for politicians, which was that they didn’t want to blame the farmers if food prices were rising. They didn’t want to blame farmers and say, “Why are you raising your prices so much?” But they also wanted to acknowledge that consumers were suffering from those high prices. So, there was this tendency to blame middlemen, or price gougers, blame the intermediaries, so that they could be supportive of consumers without seeming to blame farmers.
Beckworth: Yes, if you step back and look at the price level over US history, for many years, really up until World War I, it was almost like this straight line. It would go up during wartimes, it would come down, (we’d) have deflation. But overall, there’s this really stable price level, over several hundred years, and it might be easy or tempting to say, “Hey, Americans value price stability. Look at the price level. They’re willing to go through deflation periods.” But I guess my question to you, again, stepping back before we get into individual chapters is, is that really true? Was there this awareness (of), “We want overall long-run price stability. We have inflation during wartimes, (and) we want deflation afterwards,” or was this almost accidental? How do we attribute this amazing period of stability? Was it policy? Was it norms? Was it an accident?
Binder: Right. So, I think that it was policy, in the sense that for much of US history, we were on the gold standard or bimetallic standard, which does tend to stabilize the price level over longer runs. So, you would still – even with the gold standard, you can still have episodes of deflation or episodes of inflation, and those were, when they happened, very unpopular. But in the longer run, you would have a fairly stable price level, and that was something that people valued, and that the founders realized that people valued.
Binder: So, that was why there was so much reluctance to allow paper money during the Constitutional Convention. There was this fear that, with paper money, you would get devaluation, which would mean inflation. And people saw that as something that really violated a sense of justice, because they thought about the contracts that people wrote expecting to be paid back in a certain amount of money that would be worth a certain value, and they thought, “Okay, if we allow the government to devalue the currency, we’re really interfering with contracts. It’s like we’re stealing from some people to give to others.”
Binder: And they really had this sense of discomfort with that, and thought that it was because of that importance of not having the government interfere with contracts that they needed to keep the price level stable. That was a big theme of the book, because it was something that really motivated the quest for price stability for many decades, and it was something, even, that Irving Fisher talked a lot about during the Progressive Era, when he was advocating for the central bank to take on price stability as its primary objective.
Beckworth: So, there’s always been some awareness that price stability over the long run is a good thing, just a question of the politics and the ability to do it.
Binder: Oh, (it’s) also just a question of, how long is the long run? Even if the gold standard will bring about price stability in the long run, if it’s going to mean a decade of mild deflation, are people willing to tolerate that or not? I think that that has led to a lot of interesting issues as well.
Beckworth: Well, since you bring that up, I was going to mention this later, when we get to the postbellum chapter you have, but that postbellum period – I actually wrote a paper on that period. So, I know a few things about it, but that was like a 30-year run, (from) 1866 to 1896. Deflation, it was steep early on, (and then) it was milder, but 30 years of deflation is just shocking. I can’t imagine a world like that. Now, there were a few financial crises, but overall, the economy was growing rapidly during this time. This is also a point, though, of course, where the farmers were very unhappy, and William Jennings Bryan’s speech comes out of it, but the fact is that it happened, 30 years. Apparently, there was enough support to allow it to continue to happen. So, I’m just curious, what was in their minds? Maybe this became normal? We expect prices to go down a little bit every year – every year until it becomes the way we live.
Binder: Yes. I think that, in the same way that maybe 2% inflation seems normal to us now, I think that 2% deflation might have seemed normal then, but normal doesn’t mean that everyone accepted it. And the other important thing about that mild deflation was that it wasn’t even across – It wasn’t like the price of every single type of good was falling by 2%, and sometimes, well, certain prices fell more than others, and often, it was the prices of certain crops, or farm goods, that were falling more. So, that really contributed to the dissatisfaction of the farmers during that deflation episode. Not only that there was just aggregate deflation, but that they felt that the price of what they were selling was falling more than the price of what they were trying to buy. So, that really aggravated the problem.
Beckworth: Now, that’s interesting that you bring up the comparison (of) 2% deflation versus the 2% inflation today. During the recent inflation surge, there were these big sectoral shifts, at least big relatively speaking, from a bunch of service spending to goods, and it created these disturbances that maybe made things feel worse, and during this postbellum period that you’re talking about, farmers were also going through that. They definitely were hurting more, and I think, in part, because farming was shrinking. We were shifting from an agricultural-based economy to an industrial one, so there was real pain and a real transition cost going on. So, I guess, another theme in your book is that even though we’re striving for some form of price stability, there’s always these underlying structural changes that people may attribute to monetary policy, or to the prices, going on, even if it’s fundamentally something structural in the economy.
Binder: Yes, and an interesting comparison between then and now is the vast amount of statistics that we have available now that let us actually say, “Okay, how were prices of services rising versus prices of goods?” And we can look at these CPI reports and see exactly which types of goods and services are experiencing the most rapid price increases, which are falling in price. But back then, the national statistics were just getting started, right? And a lot of these episodes actually motivated the collection of more statistics, because there would just be arguments about, “Well, farmers have it worse because these prices are falling so rapidly,” but there wasn’t really reliable data there to prove it. And so, that did play a big role in the development of our national statistical agencies and the work that they do that we now rely on so heavily.
Beckworth: Okay, let’s jump into some of your chapters, and let’s begin with the start of this country, the colonies, and the Revolutionary War. What are the key insights and lessons from that period?
Key Lessons from the Revolutionary War and Civil War Periods
Binder: Sure. That chapter talks a bit about money in the United States before the Revolution, (and) in particular, the kind of constraints that Great Britain was placing on the monetary powers of the colonies; limits on their ability to issue bills of credit, paper money. Then, it also talks about what happened during the Revolutionary War. We have the phrase, “not worth the continental.” I’m not sure whether people of my generation or younger actually hear that phrase anymore, but if something is not worth the continental, it’s basically worth nothing because of the way that the continental currency was so devalued during the Revolutionary War.
Binder: So, we talk about what that meant for inflation and the early efforts and thoughts about potentially using price controls to address the Revolutionary War inflation and why those were not very popular, very widespread. Then, I talk about the impacts of the wartime inflation for what the founders thought about the monetary system as they started designing it. So, like we talked about earlier, there was really this recognition that price stability was very important and (there was) a pretty big skepticism of paper money because of its potential for allowing inflation. And they saw that with the continentals, with these emissions of paper money, they did get rising prices. I think that, during a war, that was accepted as something that was necessary, but it wasn’t something that they wanted to have happen outside of wartime.
Beckworth: Yes, and Alexander Hamilton, he really despised that currency, fiat money, and really put more emphasis on the debt, as I understand it. He wanted to repay the debt holders and completely wipe out the people holding the continentals. For the sake of time, we’re going to have to jump forward a few chapters. Let’s go to the Civil War, and I find that so fascinating because the greenbacks were introduced, (and) fiat money, once again, comes up. They temporarily go off the gold standard. In fact, we were just touching on this. The postbellum period was a return to the gold standard. It took many years, but one of the challenges (was that) they had all of these greenbacks that they issued in addition to borrowing a lot of money. So, what are your thoughts on that period?
Binder: Yes, this period was interesting because of all of the Supreme Court cases that happened after the fact, to say, were these greenbacks actually constitutional or not? So, there was a big question about whether it was actually constitutional to issue a legal tender paper currency like the greenbacks. This came up in several Supreme Court cases after the war, and the interesting thing is that the first ruling that they weren’t constitutional ended up being overturned. So, the greenbacks were constitutional, not just during the war, but even outside of wartime.
Binder: There were all sorts of interesting issues surrounding the greenbacks, and, again, a lot of it came down to that issue of contracts that I mentioned earlier. Since the greenbacks were legal tender, people were obliged to accept them in payment of debts. And so, of course, creditors didn’t like being repaid in greenbacks if they had thought that they were going to be repaid in gold. So, it really highlighted the way that, if you don’t have price stability, debtors and creditors are left in different positions than they originally thought they would be in.
Beckworth: Yes, so, the return to gold took a long time. I believe it was in 1879, is that right, when they finally returned to the gold standard?
Binder: Yes, it was a slow process. They called it “contracting the greenbacks.” The greenbacks were going to be contracted or withdrawn from circulation. That was deflationary. And so, there was this effort to make it occur slowly so that the deflation wasn’t this really rapid, quick deflation. But still, I think that, after the war, people saw the greenbacks as something that did have to go away. It’s something that was an embarrassment, to have greenbacks when we weren’t in a war anymore.
Beckworth: I bring this up because it took 15 years or so, from when they passed legislation to 1879, to return to the gold standard, and that’s an interesting comparison to a more recent experience when the United Kingdom- they went off of gold after World War I and tried to go back in fewer years. I believe (that it was) four or five years, and that was just too quick. They couldn’t– They were too poor. It was too quick (and) too painful, (whereas) in the case of the US, it took a long time, all of these years to return.
Beckworth: So, if you’re going to return to this pre-war ratio between gold and the dollar, it just takes time and effort. Moving forward, let’s jump to World War II. I know that some interesting things happened in World War I. We talked about the postbellum period already, but for the sake of time, let’s go to World War II, and I want to bring up World War II because you really bring out a lot of detail about the Office of Price Administration and price controls. So, how successful were price controls during World War II?
The Impact of Price Controls During World War II
Binder: So, by the time of World War II, there was this big contrast from what happened in the Revolutionary War. In the Revolutionary War, any effort to impose price controls was really limited because of a lack of – I guess we’d call it state capacity. There wasn’t a strong national government that could impose price controls broadly across all of the colonies. So, any price controls were really just done at the local level, and when you have price controls administered at a local level, they’re quite easy to avoid. If there’s a price control in one town but not in another, you can just go buy things in another town, (or) sell things in another town, right? So, price controls need to be administered broadly across the whole country, and there was just this inability to do that during the Revolutionary War.
Binder: And gradually, over the years, as state capacity grew, it became more feasible, until the time of World War II when it was possible to have this broad system of price controls with tons of government employees administering them across the country. So, you asked about how successful they are. It sort of depends on what you mean by successful. There (ARE) different ways to judge that. Were they able to hold down certain prices? Yes. Like I said, there was the capacity to do that. Were they publicly accepted? For most of the wartime, yes, also. There was this pretty widespread agreement that the main priority was winning the war, and the priority was wartime mobilization.
Binder: When you have this shared public interest in some kind of goal, like winning a war, wartime mobilization, it sort of becomes less necessary to have the price mechanism providing signals about what people want when people have a shared goal, which is winning the war. So, during a really extreme event, like a World War, that is the time that price controls, I think, are more likely to be successful than they would in normal times. So, yes, they had some successes, but there were a lot of problems as well, and especially, as the war progressed, it became more and more difficult to keep the price controls functioning well, and it became difficult to maintain public support for them and to have the production that was needed without the kinds of signals that you would get from the price mechanism. There became more politicking from different industries (that were) trying to lobby to get around the controls or get the kinds of controls that they wanted.
Binder: That lobbying itself – when the public recognized it, there was a lot of sense of things being unfair. There became more shortages of goods that consumers really wanted, and that contributed to eroding the popularity of the controls. Also, just the legality or the constitutionality of different aspects of the price control system also became questioned during and after the war. So, it really wasn’t something that would work well permanently or long-term, and that became more and more clear as the war progressed.
Beckworth: Yes, I recently had Ryan Bourne on, and he has a book called The War on Prices, and one takeaway that I took from that book, in our discussion, is that even in the best scenario – like the start of World War II, where everyone’s patriotic (and) willing to sacrifice – a price control doesn’t really get rid of the resource scarcity problem. It just puts it into a different place. So, you can deal with scarce resources by price, the price mechanism. You can do it through quality. You can do it through quantity, first come, first serve, or maybe (with) the quality, you offer lesser quality products. So, there’s all of these different margins, so you don’t really get rid of the problem. So, whenever I hear someone say, “This is the democratic way to deal with issues,” to me, I hear that they’re looking for a free lunch or that it’s going to somehow get around the resource scarcity problem. It really isn’t. It’s just a way to deal with a crisis in the moment. It’s not a long-term solution.
Beckworth: Well, let’s move forward to the post-war period, and in particular, I’m going to jump all the way into the 1970s. So, we had the great inflation, and, in fact, the whole decade is a pretty – Maybe miserable is too strong of a word, but it’s not a great time. We had stagflation; high unemployment (and) high inflation. People are unhappy. We see the dual mandate introduced by Congress. It’s actually in the Federal Reserve Act. They also were instructed to promote price stability, as well as maximum employment, and, of course, there’s a third thing in there, moderate long-term interest rates. But where do we see the Fed really coming to terms with this call for price stability? Was it the dual mandate? Was it before then? Was it after that?
The Emergence of Price Stability: From the Great Inflation Period to the Present
Binder: I think that it wasn’t until after the great inflation, during the Volcker disinflation, that the Fed really came to terms with its role in price stability. If you go back earlier to the Martin Fed, I think that he did have a modern-ish understanding about the role of the Fed. He did see his job as promoting price stability, and there’s a paper by Christina and David Romer showing that the Martin Fed behaved the way that we would expect a modern central bank to behave, as far as the way that they adjusted interest rates to try to achieve price stability.
Binder: But once we got into the 1960s and 1970s, there was a departure from that. The most extreme (departure) would be under Chairman Arthur Burns during the great inflation. He was actually an advocate of what he called “incomes policies,” which means price and wage controls, because he didn’t think that the Fed alone, that monetary policy alone, was the way to stabilize prices. He thought that it would be far too costly to try to use monetary policy to address the great inflation, and he actually tried to help to convince Nixon that price and wage controls were the way to go. So, it would be shocking today to hear a Federal Reserve Chair argue for wage and price controls, which shows you how much things have changed since then. But once Paul Volcker demonstrated, with the Volcker disinflation, that monetary policy was effective, even if sometimes a costly way of gaining price stability, then, I think that became much more recognized and accepted.
Beckworth: Now, this whole period is very fascinating to me. You see the Fed beginning to embrace the natural rate hypothesis. They begin to think more seriously about having a credible nominal anchor. All of these ideas from the academics are filtering into the Federal Reserve. There’s always political pressure, which, even if you do have the right theory, can still push back against it. What do you think Volcker had by the time he was Fed Chair? What did he think he was doing, intellectually? Did he just think that (jacking) rates up high enough (would) create destruction and that the economy (would) cool down, or did he have some other theory in his head about how this would work?
Binder: That’s a good question. I think that he really did believe that monetary policy was the way to achieve price stability, and he saw himself as the one to do it no matter the cost. So, he was going to stand up to any sort of political pressure that he got, any sort of personal pressure that he got to keep monetary policy easier. He (didn’t) quite do it on the first try, right? There was a little bit of stop and go at the start of his chairmanship, but eventually, he committed to it and saw, “Okay, we have to do this,” (and) that there was no other way. They had to suffer a recession, no matter how costly, to get inflation under control, even if that made him really unpopular at the time. As it turned out, he was quite popular after the fact, I think.
Beckworth: So, in the book, you get into Alan Greenspan, who goes (to) the next step and really begins to anchor inflation expectations, and then Bernanke, who follows him. It’s not until the ’90s that we actually see these debates at the Fed about price stability, at least explicit ones, that I’m aware of, and we begin to see this, and maybe some of the pressure was from other central banks adopting inflation targets. Then, in the 2000s, I think there were more debates, and eventually, Bernanke comes, and he’s leading the charge on adopting an inflation target. Why do you think it took so long for the Fed to explicitly adopt an inflation target?
Binder: Well, I think that Alan Greenspan was quite reluctant to have an inflation target be explicit. It has been called the “Greenspan standard,” where he basically kept prices stable based on his own personal reputation for price stability. That led to some concern about, well, what is going to happen when Greenspan is not the Chair anymore? What is going to be our nominal anchor? We can’t just rely on one man’s reputation as our nominal anchor.
Binder: It’s interesting because Greenspan gradually allowed more transparency at the Fed, and transparency is one of the hallmarks of the inflation targeting approach, but he never went so far as to say, “Okay, we’ll have a 2% target,” or “We’ll have a 3% target.” So, he allowed transparency to an extent, but not to the full extent. It really was Bernanke who was a big advocate for inflation targeting and, I think, responsible for eventually getting the Fed to adopt it.
Beckworth: Yes, and we had 2012, (where) Bernanke leads the FOMC and the Fed into adopting an official target, and they have their first-ever Statement on Longer-Run Goals and Monetary Policy Strategy. It’s like their constitution. It was updated in 2016, I believe, to include the word “symmetric” because inflation had been running low. And, of course, in 2020, FAIT is introduced as makeup policy, and here we are – to circle back to where we started this conversation – here we are on the cusp of a new Fed framework review. Two questions: Do you see the Fed framework review (AS) really just a continuation of this journey that you’ve outlined in your book? Then, secondly, where do you think the Fed will land with the new framework review?
The Direction of the Fed’s Framework Review
Binder: Sure. So, in the book, I do talk about the previous Fed framework review, the Fed Listens campaign that culminated in that new Statement on Longer-Run Goals and Monetary Policy, and I’ve read through the reports from that earlier review and all of the different interviews and listening sessions that the Fed did with various interest groups. So, they talked with a lot of consumer groups, union representatives, representatives of retirees, and so on.
Binder: And there was a lot of a sense in 2019 that, well, what the public really needs – what people really want – is full employment, and that the Fed should, really, weigh heavily the public’s desire for full employment, even if that means being willing to allow inflation to rise temporarily above target. So, I think that there was a lot of a sense that, “Why should the Fed ever tighten policy just because they expect above-target inflation to come, down the road? They should wait until inflation is actually above target before tightening, to give the labor market a chance to be at full employment for as long as possible.”
Binder: I think that that did get reflected in the asymmetry of the new framework, and I think that this next framework review will question that earlier reasoning and say, okay, there is some reason for the Fed to be forward-looking and to respond to what they expect inflation to do, rather than wait and see what happens and then respond after the fact. So, I think that that might come out of the review, a sense of, “Okay, we are going to respond to our expectation of future inflation, rather than only responding to inflation once it rises above target.” That would actually be a pretty major change. It would sound like a fairly small change, but if the Fed were to say, “Look, we’re going to be fully forward-looking in that sense,” (then) I think that that would be a pretty big thing to come out of the review.
Binder: I think it is good that the Fed is doing these reviews. Some central banks, like the Bank of Canada, do them on a fixed schedule. I think the Bank of Canada does a review every five years, which I think is good for accountability and just for the quality of the institution, that they are reviewing what’s happened in previous years, that they’re getting input from people both inside of and outside of the system, and providing a chance to get new opinions in. It also gives them a chance to just tell the public, “Yes, we’re still committed to inflation targeting, and here is why,” and to address any concerns that might have come up about the way that they do monetary policy.
Beckworth: And we hope that the Fed follows that pattern and will read your policy brief along with the other authors in our series that we’re going to be releasing soon. Well, with that, our time is up. Our guest today has been Carola Binder. Carola, thank you so much for coming back on the program.
Binder: Thanks, David.
