Soon after the Great Inflation got underway, policymakers began looking for solutions. Ever since 1934, the $35/oz. gold price peg had provided a sort of anchor for prices. Yes, it was a weak anchor, as the gold standard was gradually being dismantled, but it still had some ability to hold down inflation expectations. Once that price peg was lifted in March 1968, LBJ looked for alternative solutions. His first choice was MMT. Then Nixon tried statism (or socialism, if you want to troll the Sanders/AOC supporters). Then Carter tried Keynesianism. They all failed. Then Reagan tried monetarism. He succeeded. This is their story.

In 1968, LBJ raised taxes sharply as a way to slow inflation, the MMT solution. In one sense this policy was a smashing success, as the budget swung into surplus during the 1968-69 fiscal year (which went from July to July in those days). That was a mind-boggling accomplishment at the time. When does a country balance its budget in the midst of a major war, and when it is also rapidly scaling up the “Great Society”? (Everything from expanded welfare, to Medicare, Medicaid, housing programs, moon landing, etc.)  That’s crazy!

Unfortunately, it was a complete failure at holding down inflation, which continued to accelerate.  That’s because it was based on the false model that fiscal policy determines inflation, whereas in fact it is monetary policy that determines inflation.

In August 1971, Nixon adopted wage/price controls.  These did briefly slow measured inflation, but by 1973, inflation was soaring to new highs even as shortages were developing.  Nixon ended the controls during 1974.  (And no, the 1972-81 inflation was not about oil, as NGDP grew at 11%/year and RGDP grew by a bit over 3%/year. It was money.)

During 1979-81, Carter’s Fed adopted a high interest rate policy to control inflation.  Almost everyone in the world, both left and right, gets this wrong.  They draw a sharp break between the period before August 1979, when G. William Miller led the Fed, and the next 8 years, when Volcker led the Fed.  Actually, the 1979-81 policy that led to America’s highest inflation rates since WWII was produced by both Miller and Volcker; the actual policy break toward tight money occurred in mid-1981.

Keynesians have a bad habit of reasoning from a price change, assuming that inflation comes from an overheating economy (it comes from easy money), and they also have a bad habit of assuming that high interest rates represent tight money (sometimes, not always).  They wrongly see high interest rates as a way to control inflation.  That’s like saying “High oil prices are a good way to reduce oil consumption.”  Not if the high oil prices are caused by public policies that boost oil demand.  People need to stop reasoning from a price change.

During 1979-80, the high interest rates were caused by an easy money policy, which boosted interest rates via the income and Fisher effects (mostly the latter.)  That’s why this Keynesian policy failed.  For you econ nerds, the Fed shifted the IS curve to the right (via bad signaling), boosting interest rates, while it wrongly believed that it was shifting the LM curve to the left, an alternative way to create high interest rates.