Part 3: David Wheelock, The "Great Inflation" Period and the Emergence of the "Maverick" Reserve Bank

May 6, 2014 | St. Louis Mo.

Jumping 50 years forward, Wheelock explains how the St. Louis Fed began to set itself apart from the nation’s other Reserve banks. It gained its “maverick” reputation amidst the “Great Inflation” of the 1970s as St. Louis President Darryl Francis (1966-1976) and his team argued that the Fed’s viewpoints and actions at that time (including its “stop-go” monetary policy and Keynesian-influenced view that higher inflation could lower unemployment) were causing more harm than good. Wheelock describes how Francis was willing to buck the system, aided by the analysis and data provided by director of research Homer Jones (1958-1971). The St. Louis Fed went public with its viewpoints and began to publish much data and analysis. To this day, the St. Louis Fed is well known for its publication of data and economic analysis.

Presentation (.pdf)


Dave Wheelock: Now let me jump 50 years forward and talk about, as the video said, an important era in this bank’s history which began in the 1960s and continued through the 1970s. And it really set the St. Louis Fed apart in a sense from the other 12 banks and gave us this reputation as the maverick. And that had to do with the Great Inflation. Now as I’m sure most of you will recall, the 1970s where we had the oil shocks and the hype inflation and the very weak economy, high unemployment at times, and that economists refer to as the period of the Great Inflation.

From the 1950s up until the mid-’60s, we had a very low inflation rate, about 1-1.5% on average—very close to what we have today in the United States. But then, beginning about 1965, inflation began to rise. And it was slow at first, but then it increased over time. And in the 1970s there were two periods when the inflation rate at an annual level exceeded 12% on a year-over-year basis. But you also notice it wasn’t a straight line up. It was up and down and up and down, and the amplitude got more and progressively and progressively worse.

These shaded areas represent periods of economic recessions, periods when the gross output of the economy was contracting, when the unemployment rate was going up, very significant weakness in the economy. And they would coincide with these peaks in the inflation rate. And hence the term stagflation was coined. Stagflation are periods of high inflation coupled with high unemployment.

Jimmy Carter when he was running for President in 1976 coined the term the misery index, where he essentially said you add together the inflation rate and the unemployment rate and you get a misery number. That shows you how much the economy is suffering. And he used that to defeat Gerald Ford in the 1976 Presidential election.

So, what was going on here? And where was the Fed at this time? And what was the Fed’s position about what was going on in the economy at the time? Well, the Board of Governors through most of the 1970s was chaired by Arthur Burns. Arthur Burns had been President Eisenhower’s Chairman of the Council of Economic Advisors. He was a PhD economist and very well-respected economist. And President Nixon appointed him to succeed McChesney Martin in 1970 as Chairman of the Federal Reserve Board of Governors.

Burns held the view that the inflation was being caused by increased government spending and budget deficits. He didn’t think much of President Johnson’s Vietnam War or Great Society programs, which are increasing government spending and increasing the deficit. He also blamed OPEC, of course, for the oil price shocks, for the big increases in oil prices and that was going on in the ’70s. He also blamed labor unions for demanding and receiving what he considered to be excessive wage increases. And he blamed monopolists, firms for setting prices too high.

So it was a very non—the Fed is not to blame in this. Burns’s view was that the best way to bring inflation down was to impose wage and price controls. In the early 1970s, President Nixon did just that, as you may recall—impose wage and price controls for a time. Now that was not the only view held among economists. There was another camp which became known as the monetarists. Milton Friedman, the famous University of Chicago economist, was kind of the leader of the monetarist camp. He had a disciple and a former teacher as Research Director of the St. Louis Fed in Homer Jones.

Homer Jones had at one point taught Milton when Milton was an undergraduate and had become Milton’s student later when Jones was getting his graduate degree. And so the monetarists, including Homer Jones, blamed the Fed for the Great Inflation. In essence, inflation is caused by monetary policies that allow the money supply to grow too rapidly. There’s too much money chasing too few goods. Prices get bid up. You get inflation.

Moreover, these widely swinging cycles of inflation were due to a policy that was often referred to in those days the stop-go monetary policy, where the Fed would push hard on the gas pedal for a while to try to speed the economy up to reduce unemployment. But then inflation would take off, and then the Fed would slam on the brakes to do something about bringing down inflation. But then you’d have a recession, and that would cause the unemployment rate to go up. Then the Fed would step on the gas and repeat the process.

So slam on the brakes to fight inflation, but that turns out to cause a recession. Unemployment goes up. So then you step on the gas pedal, pump money into the economy to do something about ending the recession, and that causes inflation to go up. It was a recipe for disaster. So, in a nutshell what was happening was, beginning in the early 1960s as the economy was coming out of a mild recession in 1960, the Fed put the gas pedal down part way. Inflation started to take off. Then the Fed famously tightened monetary policy.

1965, late 1965, the money supply growth rate declined. The inflation rate slowed a bit. It didn’t come all the way back down. President Johnson didn’t like it a bit. He didn’t like high interest rates. He didn’t like the fact that money was getting tighter. He called McChesney Martin to his ranch in Texas, chewed him out, told him to back down, to cut the discount rate, to let interest rates come back down. Martin did not break. But he did bend a bit. Martin believed that the Fed had an obligation to support the government’s policies in general, so he defended the Fed’s independence but within government.

And so the Fed stepped on the gas again. That generated more inflation. Arthur Burns takes over in early 1970 just after Martin’s turn ended. And Martin had slowed the growth rate of the money supply to deal with this inflation, but that resulted in this recession. Burns takes over. He says, “New era. We’re going to expand the money supply rapidly. We’re going to use wage and price controls to do something about controlling inflation.” And so the money supply takes off, but then, subsequently, inflation takes off and you get this big spike here. Wage and price controls don’t work.

Prices, when they come off, inflation takes off and skyrockets. The Fed tightens again. You get the recession in 1975. And the Fed reacts to that by another round of stepping on the gas, and you get this repeated cycle, until finally in the end of 1979 the Fed finally changes policies to deal with that. So that’s the stop-go monetary policy. Now the Fed, the St. Louis Fed, throughout this time was arguing that what the Federal Reserve as a whole was doing was causing this stagflation problem of these wide swings in the economy. There’s Homer Jones on the right with one of his economists, Leonall Andersen.

So the St. Louis Fed view was that inflation was caused by excessively rapid growth of the money supply. Wage and price controls will not work. They’re not a permanent solution to ending inflation. Stop-go monetary policy is bad for the economy. You get these wide swings. You get the recessions. It just isn’t helpful. It’s harmful.

Moreover, there was a strong view in those days coming out of the so-called Keynesian economists that if we would only accept a somewhat higher permanent rate of inflation we could lower permanently the rate of unemployment. So there was that view, that, “Well, we can get by with 5% or 6% inflation if that will reduce the unemployment rate down.” And so there was a view that you could actually work a trade-off there by accepting more inflation to lower the unemployment rate. The St. Louis Fed argued that that just wasn’t so.

So the Board didn’t want to hear it. So the man on the left is Martin, again, who was the longest-serving Chairman of the Board of Governors from 1951 to 1970. Burns takes over in 1970 and serves to 1977. And then that’s Darryl Francis on the right. Now a few years ago before Darryl Francis died, an economist at the Federal Reserve Bank of Richmond did an oral history with Francis, and he talked to Francis.

So I’m going to play a little audio clip here. You’ll hear two voices. You’ll hear Francis’s voice, and you’ll also hear that of Bob Hetzel, the economist from the Richmond Fed who was asking Francis the questions. And Francis is talking about the different styles that Martin and Burns had. And I think you’ll get a real sense of what Francis thought of the two gentlemen.

[Begin audio clip.]
Darryl Francis: Bill Martin was quite a fellow. And I remember him when he conducted an FOMC meeting. He listened to what everybody else had to say before he put himself on the line.
Bob Hetzel: Hm-hmm.
Darryl Francis: And my memory is that after he’d [heard everybody else 00:10:09] he would draw from that what he thought was the consensus of those who had spoken. And then if he didn’t agree with it, he would tell us so.
Bob Hetzel: So you don’t feel like he came into the meetings having his mind made up, basically, and—
Darryl Francis: Oh, well, he may have. But he didn’t try to influence the committee before they started. Burns, on the other hand, wanted the committee to damn well know where he stood before he listened to anybody else.
Bob Hetzel: So Burns would speak first?
Darryl Francis: He let you know where in the hell he stood, yes.
[End of audio clip.]

Dave Wheelock: Francis and Burns didn’t get on too well. (Laughter.) So the Fed—the St. Louis Fed was led by Darryl Francis, who was president from 1966 to 1976. Prior to that—prior to becoming president, he was the first vice president of the bank. He had a master’s degree in economics. So he was a pretty smart fellow. And he was tutored by Homer Jones, the bank’s research director, who served from 1958 to 1971. Now Francis was willing to buck the system, and Jones gave him the analysis, the data he needed to do so.

The St. Louis Fed also went public, which really ticked off the Board of Governors and Burns. The Fed, the St. Louis Fed, was very public in their views, and they began to publish a lot of data on monetary statistics showing how rapidly the money supply was growing, how that was correlated with the increase in the inflation rate. To this day, the St. Louis Fed is well-known for its publication of data and other economic analyses.

We have our FRED database, which you may be familiar with. It’s an online tool which has thousands of economic data series. But it got its start here under Homer Jones publishing paper copies of monetary data. And then there was analysis. I mentioned here a famous paper by Andersen, whose picture I showed up earlier, and Jerry Jordan. Jerry Jordan was an economist at this bank in the 1960s and ’70s. He went on to become president of the Federal Reserve Bank of Cleveland in the 1980s.

And they wrote a very famous article that was published in the Federal Reserve Bank of St. Louis Review showing the importance of money supply growth as a determinant of economic activity. Prior to that article, the St. Louis Fed Review and the publications of all other Reserve Banks were basically just giving local or regional economic data and information. There wasn’t much true economic analysis in it.

Andersen-Jordan is important, because it really shifted the focus away in the research divisions from merely collecting data about the local economy to actually doing real policy analysis and economic research in more of an academic tradition and supporting their president when he or she—and it was all he in those days—when they would go to Washington to deliberate on monetary policy with the rest of the Federal Open Market Committee. So I mentioned Milt Friedman a few minutes ago. He was a visitor at the St. Louis Fed a number of times starting in the 1960s, as were a number of other academics.

And we remain very integrated with the academic community here at the St. Louis Fed. We have very close relationships with the Economics Department in the business school at Washington University here in St. Louis. But we have visitors who are academics, and Central Bankers from all over the country, in fact all over the world, are frequently visiting here at St. Louis, because they bring us fresh ideas and fresh knowledge and teach us about the modern economics that helped us provide the policy support for our president. And then Francis was going out and giving these public speeches.

Now the Board didn’t like it a bit. There was an article in BusinessWeek magazine—I forget when it was—around 1970, where the maverick phrase term comes from. “Maverick in the System” is the title of the BusinessWeek article. So Francis and the St. Louis Fed was getting a lot of press. And, again, the Board didn’t like that. The Board considered—or the FOMC considered proposals basically to squelch research done at the Reserve Banks. Their word was to coordinate it, but that essentially means, “Okay, you guys tell us what’s going on in the Eighth District, but leave the policy analysis and the national economy to us.”

Review articles were subjected to approval by the Board of Governors before we could publish them in our Review here. The Board of Governors rejected the nominee of our Board of Directors to succeed Francis as president. Our Board of Directors put forward a man who was then our first vice president, who had been knowledgeable about monetary policy. And the Board said no. They rejected that man. Instead, they appointed Lawrence Roos, who had been the County Executive of St. Louis County—not an economist, but clearly, as County Executive, he had administrative experience.

And Burns told Roos, you know, straight out that, “St. Louis is a broken bank. It needs fixing. And we want you to go in there and straighten them out.” Well, what is the legacy of that? St. Louis lost many battles in the ’60s and ’70s. But, eventually, in some sense we won the war, because when Paul Volcker became Chairman of the Board of Governors in 1979, the Board and the rest of the system recognized that inflation is fundamentally caused by bad monetary policy. It’s the Fed done it, and not OPEC, not budget deficits and so forth. It’s bad monetary policy that causes inflation.

So, starting with Volcker, the Fed accepted that controlling inflation is the responsibility of the Federal Reserve. And the other Reserve Banks began to copy the research focus of the St. Louis Fed. They saw that Francis was coming to FOMC meetings well-armed with arguments and data and analysis to support his case for a particular monetary policy. Essentially, the other Reserve Bank presidents thought, “Well, we need to beef up our research staffs too and build up the ties with the academic community so we can be similarly supported and come to the table and deliberate monetary policy with a well-armed analysis.”

And St. Louis continued to emphasize this tradition of research, of providing information to the public through our various websites and publications, and also supporting economic education, as Martha had said earlier. So the lesson in this is that the structure that the founders created in 1914, this regional structure, this hybrid political compromise, has a number of advantages, one of which is it promotes a diversity or enables a diversity of views to be heard at the policy table. We’re not all reporting to the same chairperson in Washington.

As an economist at the St. Louis Fed, I report only to my bank president. He reports only to his Board of Directors. We don’t report up to Chair Yellen or Ben Bernanke or [unintelligible 00:17:31] or the other members of the Board. Now, of course, the Board has considerable oversight. It controls our budget and so forth. You know, so it’s not that we can just go off and do crazy things like holding public lectures like this. (Laughter.) But there is certain advantages, and it allows us this competition of ideas, if you will, and innovation in the Reserve Banks to take hold and try out new things and experiment and see what works and what doesn’t. So…

Martha mentioned there are a few websites where you can go to for more information. The Federal Reserve Bank of St. Louis Annual Report will be published in the next two or three weeks. It’s basically a historically devoted issue. It will be available on our website. But Mary and Julie and other members of our senior management also contributed essays to the annual report about their individual divisions as well and what’s going on there and how they’re looking forward.

I should also mention, the St. Louis Fed has a Centennial website of our own. It’s connected with our Fraser database, which is a lot of archived historical material about the Federal Reserve, much of which had not been digitized until our staff connected with Fraser. And I’m happy to see Barbara here, Barbara Dean, who was very instrumental in getting that digitization work going and digitizing a lot of the historical material of the Fed and making it publically available. So that’s Fraser. And then, as Martha mentioned, there is a system historical gateway, which has considerable information as well.