Robert Samuelson: "The Great Inflation..."

[This review ran in the FT earlier in the week and I forgot to post it here. Sorry.]

Robert Samuelson, who writes for Newsweek and the Washington Post, has for years been one of the most interesting economic commentators in the US. He stands for independence and lack of agitation, real or synthetic. He has no time for exaggerated alarms and enthusiasms. He is steady in a boom and steady in a crisis. Except that he writes too well, he might have been a good central banker.

His new book about the "Great Inflation" of the 1960s and 1970s and its far-reaching consequences has a lot to say about central banking, but it strives to put debates about monetary policy in a wider setting. It is an excellent subject and, as he says, a book that needed to be written.

Inflation in the US increased in those decades, he argues, because of good intentions combined with bad economics. After the second world war politicians had fresh memories of the Depression and were sensitive to the costs of unemployment. Maintaining full employment was the good intention. The bad economic idea was that monetary and fiscal policy could be fine-tuned to do this continuously.

Many economists then believed it was possible to exploit a stable trade-off between inflation and unemployment. Accepting a slightly higher rate of inflation would allow a permanently lower rate of joblessness: a small price to pay, many believed. In addition, estimates of how far down unemployment could be pushed were very optimistic: rates of less than 4 per cent were regarded as unambitious. A third ingredient was the view that inflation was not chiefly the result of monetary policy: if inflation crept up, it was because of "cost-push" factors (such as wage demands) which the central bank could not affect.

In the view of most economists, all those ideas now stand discredited. Accepting a higher rate of inflation does not yield a permanently lower rate of unemployment; the "natural rate" of unemployment (the amount consistent with inflation that is neither rising nor falling) is higher than 4 per cent; and expansionary monetary policy does indeed drive inflation up. The views prevailing in the 1960s and 1970s were a formula for policy erring always on the side of expansion, which ratcheted inflation ever higher.

Once US inflation had risen above 10 per cent, it took Paul Volcker at the Federal Reserve, Ronald Reagan in the White House (prepared to give Mr Volcker political cover), and an unexpectedly severe recession in 1981-82 to bring it back down. There followed more than two decades of the "Great Moderation", as it is called: steady growth, low inflation, and muted business-cycle fluctuations. Discussing this in 2004, Ben Bernanke, now the Fed chairman, called the "substantial decline in macroeconomic volatility" over the previous 20 years "a striking development". Was it due to structural economic change, better monetary policy, or good luck, he asked? His answer: monetary policy, mainly. The lessons had been learnt.

Four years on, with the roof falling in, Mr Bernanke's verdict on the new-found wisdom of central bankers looks a little premature. Mr Samuelson's book also feels overtaken by events and, in its last parts, thrown into confusion. He writes, "In many ways, the book's publication - about two years later than I originally expected - is more timely now than if I had written faster and made my initial schedule." I think not. The present crisis overhangs the narrative and demands to be properly integrated. Had the author known what was coming, this is not the book he would have published at the end of 2008. The Great Moderation is over. We are living new and unforeseen chapters, and the book does not have them.

Rather than simply stopping short, the book does attempt some discussion of the crisis. With less than full conviction, it suggests that the Great Moderation fell victim to an internal contradiction: low inflation fuelled reckless optimism which spilled over into speculative excess. No doubt there is something to that, but the idea cuts awkwardly across the theme that Samuelson presumably first had in mind, and which is stamped through the book - that a kind of social contract was struck after 1982, in which people accepted less fine-tuning of the economy in return for low inflation and steady growth. Was that a good deal, as the book seems to want to say? Or was it false advertising - as the view that the Great Moderation carried the seeds of its own destruction would imply?

Like everything Samuelson writes, this is an absorbing read. The main part of it, which deals with settled economic history, can be warmly recommended. But the history is not as settled as one supposed, and suddenly the aftermath of the great inflation seems less interesting, and less important, than the aftermath of the aftermath.