who are the winner and losers from inflation? the primary responsibility r controlling inflation rests with the national administration. finally, in the 1970s, the government was pushed to take drastic action. what was the result? rising prices became a fact of life despite the clamor to do something about it. inflation: how did the spiral begin? with economic analyst richard gill, we'll explore that on this edition of economics usa. i'm david schoumacher.
what is inflation? here at the bureau of labor statistics, they measure inflation, in a sense, with the consumer price index, totaling the costs of goods and services, then comparing them from month to month and year to year. inflation has affected everybody. some look back nostalgically to the three-cent postage stamp. when prices go up a little, we're not surprised. but when they get out of hand, we take notice, as we did in the late 1960s when prices began spiraling upward.
what caused that spiral? as the country grew in the 1950s, no one was worried about inflation. then late in the decade, the economy cooled down. that became a factor in the 1960 elections. i'm not satisfied to have 50% of our steel mill capacity unused, or when the united states had last year the lowest rate of economic growth of any major industrialized society. president kennedy called for a new frontier, a new era of energy and spirit. the election may have been close, but there is general agreement that a supreme national effort will be needed in the years ahead to move this country safely through the 1960s. this new activist approach was to be reflected in economic policy. walter heller chaired
kennedy's council of economic advisors. kennedy was our first keynesian president. it isn't that others hadn't done some keynesian things, but kennedy did it in an avowed and perceptive way. he was very cautious at first. he finally saw a more liberal approach was needed to stimulate the economy. it took the form of a massive tax cut proposed in i962. this net reduction in tax liabilities of $10 billion will increase the purchasing power of american families and business enterprises in every tax bracket. but john f. kennedy didn't live to see his programs enacted. instead, on that fateful november day, lyndon baines johnson was sworn in as the 36th president of the united states. johnson pursued kennedy's economic proposals
and pushed the tax plan through congress. how well did it work? perfectly. business week, which isn't exactly a liberal pro-kennedy publication, said it probably was the most successful tax cut in history. it came out of the textbooks. it went back into the textbooks as the fiscal measure that came closer to carrying out what people had projected for it. that was a tax cut that worked. the economic policies of the kennedy-johnson administration had stimulated demand, creating growth in the economy. business was booming. jobs were plentiful, unemployment near an all-time low. but many observers, including the president's council of economic advisors, were concerned about the appearance of inflation
as the economy heated up. [james duesenberry] but in 1965, the real aggregate demand was rising at an annual rate of nearly 8%. it was continuing to rise into 1966. that produced the high-capacity utilization, the ring raw materials prices, and the decline in unemployment accompanied by labor shortages. many economists felt a tax increase would take money from consumers and business. spending would drop, inflationary pressures retreat. but as the tax measure was debated, the white house would unleash new inflationary forces. johnson didn't want to hear warnings about inflation. lyndon johnson had a dream of a great society. this administration today, here and now, declares unconditional war on poverty in america.
lbj began to build his great society. but the big budget item wasn't the war on poverty. it was the war in vietnam. the defense department said it spent a billion dollars a month. as we found out later, it was costing more. between two and three times more. we were not fully aware, not even as economic advisors in washington, let alone the outside consultants, how much vietnam was going to cost. we were taken unawares for several months. but by december of 1965, still early in the game, i urged him to go for a sizeable tax increase.
he said, "walter, i've checked both houses of congress. i couldn't get a dozen votes." the problem stemmed from the kind of war this was. it was never declared a war. one main problem was the idea we would run it on the cheap. lyndon johnson wanted to run the war without letting people know we're at war, a silent, invisible war. therefore, he didn't want to raise taxes. he wanted to do the guns-and-butter, the domestic programs and the war. the stage was set for the surge of inflation. without a tax increase or other effective restraints, business, consumers, and the government kept spending. businesses worked near capacity, labor near full employment.
expensive new factories were built, and competition for workers bid up wages. the demand exceeded the economy's ability to supply, and everything began costing more. finally, the president declared a one-year 10% surtax. but was it enough? was it in time? he didn't want to fight for a tax increase on the backs of an unpopular war. it wasn't enacted till '68, and the horse was out of the barn. in the 1960s, we had a go-go economy. consumer demand ran at a feverish pitch, as did government spending. that began a cycle of inflationary pressures that would continue for a long time. does a booming economy go hand in hand with inflation? we asked economic analyst richard gill.
in the 1960s, most economists would have said inflation occurs when the total-- the aggregate-- demand for goods and services in the economy is expanding faster than the aggregate supply. everybody wants more goods, which aren't available. prices go up. this was the keynesian analysis. these are simplified keynesian-style aggregate demand and supply curves, similar to but not exactly the same as the curves we might draw for a particular product, say, refrigerators. here, we are dealing with supply and demand for the total output of the nation, its gnp. on the vertical axis, we are now measuring the price of output in general. that is, the price level. let's concentrate on one feature of these curves--
the shape of this keynesian-style aggregate supply curve. it is drawn quite flat through most of its range until we approach this line, which represents full employment gnp. then, suddenly, it goes up quite sharply. start here, far from the full-employment line. our level of gnp is low. our price level here. we now try to increase aggregate demand. the tax cut of 1964, giving more income to consumers, would be a perfect example. gnp now goes up, meaning more production and jobs for everybody, but the price level remains the same. we have growth without inflation. look here. we faced this in the late 1960s. demand was already high. the great society programs had been launched.
the vietnam war suddenly gives demand a big shot in the arm. our aggregate demand curve shifts up here. look at the difference. the increasing demand's effect goes into higher prices. we're already producing at the economy's capacity. supply does not increase. we have entered the world of demand-pull inflation. keynesians felt that the economic cure was simple. lower demand by raising taxes. if a tax cut can raise demand, a tax increase can reduce demand. we can never know how this remedy would have worked. it wasn't tried. what is certain is that inflation was to become, in the years following, a more complex and painful phenomenon. inflation, a source of anguish and despair as it undermines purchasing power
and eats away at savings. it's hard to plan for inflation. when it spreads rapidly, many are unprotected, particularly those on fixed incomes. but there are those who benefit from unexpected rising prices. just who are they? people in debt can gain from inflation. the great middle class traditionally goes into debt to buy a house. when interest rates on existing mortgages are lower than the rate of inflation, home owners win. they repay their loans with cheaper inflated dollars while their property values rise. mr. and mrs. lawson found they had a windfall from inflation. i realize that inflation has been a serious problem for many people, but it really hasn't affected us too much, with our house payments remaining essentially constant.
the interest rate-- it was an fha loan of 5 1/4%. we're fortunate that inflation really hasn't bothered us. there were other winners. this wave of inflation coincided with the credit boom of the late sixties. consumers were urged to buy on credit. buy now before prices go up. pay later with cheaper dollars. consumers were spending money. increased demand was creating jobs. so businesses would seem to be winning, but many soon had second thoughts. business does not fare well overall during inflation. at the initial stages, some businesses think they are better off because profits seem to rise. you have a situation where your inventory cost is low.
you purchased goods previously. inflation comes along and you raise prices. it looks like you get a bigger profit. suddenly, costs begin to soar. you have this uncertainty. suddenly, most businesses are worse off. that often leads us to recessions. among those clearly worse off were senior citizens. mostly they lived on fixed incomes. they had no extra money. how could they meet raises in rents, heating, or food? it seemed that when you became old, if you had not been fortunate enough to put aside or prepare to take care of yourself when you were aging, that you didn't deserve any better. that was a common feeling. but the seniors organized and made their voices heard.
in those marches, we achieved recognition that social security was still inadequate. our long goal was to secure a way in which we could link the consumer price index to regular increases, so you wouldn't have to beg congress and beg an administration which maybe was conservative and didn't want to give us anything. we felt that if that was automatic with the consumer price index increases, that would be better. it would be less political. we finally achieved that. others hit hard by inflation were the working poor and the unemployed. most of their money went for necessities. the prices of those basics-- food, fuel, housing, health-- were rising the fastest.
like the seniors, the poor attempted to organize, but their efforts were not as successful. the senior citizen movement, in terms of participation, has been a more effective movement than the poor. the poor are not organized. they vote less than others. they join groups less than others. the poor aren't like the organized workers. even the organized worker had problems keeping up. in new york, first the sanitation workers struck for higher pay. shortly afterwards, firemen and police went out. then came the transit and teachers' strikes. each group, fighting to hold on to a decent living. we asked victor gottbaum, who represents new york public employees, to recall those turbulent days. i represent workers.
if they're taking a beating, i hear about it. they don't make unfounded or loud demands. a sewer laborer says, "mary goes into that market. vic, it's killing me." that's what i hear. a hospital worker says, "it's becoming awful." that's what i hear. workers won higher settlements, but that raised costs and boosted prices. in all economic sectors all over the country, inflation became entrenched. it was hard to keep up. it was harder to feel sure who was winning. the cry to do something came from more quarters. was there any real hope that the inflation momentum would run out of steam? were we victims of our expectations that inflation would continue? we asked richard gill. there was little hope at this time
that the inflationary momentum would run out of steam. when inflation gets going, all groups feel they are losers. sanitation workers, teachers, senior citizens, rich man, poor man,you name. everybody faces higher prices and thinks, "i'm being ruined." this perception that everyone is losing is unjustified. if prices are going up, incomes are going up, too. not everybody is losing all the time. still, when this uncertainty about the future becomes contagious, things can get bad for everybody. it's difficult running an efficient, productive economy when prices change all the time. but whether justified or not, this fear of falling behind can be a major factor causing inflation to increase. sanitation workers feel they're falling behind.
they strike, getting higher wages. now other public employees see they're behind. they demand even higher increases. now coal miners, assembly line workers, sales clerks, see they're falling behind. up we go. wages, prices, wages, prices. the spiral is upon us. how on earth can it be stopped? by the end of the 1960s, the question wasn't only real, but urgent. president johnson shrugged off the importance of inflation. but by early 1969, when the inflation rate climbed to over 5%, it could no longer be ignored. the business community and consumer groups demanded that something be done. the responsibility was left to richard nixon. the primary responsibility for controlling inflation rests with the national administration and its handling of fiscal and monetary affairs.
but would this president be willing to accept the traditional keynesian approach to reduce demand by increasing taxes? chief economic advisor paul mccracken explains nixon's reluctance. i don't know of any political situation short of a war, where there isn't hesitancy about increasing taxes. that's the least popular thing the political system wants to hear. increased taxes were likely not only to cut inflation, but also to slow the economy. nixon believed the 1960 economic slowdown had cost him the presidency, and his eye was now on the 1972 elections. nixon was a laissez-faire conservative. he feared increased revenues would increase government's size and role. if taxes wouldn't be raised, why not cut back on federal spending?
it would have been irresponsible to start with a cleaver, slicing everything, partly because, i'm sure, a year or so later, government would be trying to increase everything they could increase. better to stay in the middle of the stream. if increasing taxes or cutting the budget were unpalatable to richard nixon, perhaps the federal reserve could combat inflation. the inflation rate is a function of the money supply. by restricting the money supply, inflation should also contract. the fed cooperated. the result? one thing that was expected then by congress was that the price level would respond to restraint, monetary and fiscal restraint, much more rapidly than, in fact, it did. so there was a tendency to say,
"well, the policies are failing." as the restrictive policies did take hold, the economy slowed down. unemployment mounted. there was an outcry against this made-in-washington recession. but inflation was barely affected. it was entrenched. people expected it to continue, and it did. could stronger medicine contain it? critical economists and politicians called for the government to freeze prices and wages. those controls worked during wartime, but they had never seriously been considered in times of peace. controlled wage and price ceilings interfered with the free market and laissez-faire traditions. elections were 18 months away. something had to be done. but could a conservative like nixon accept price controls? the time has come for decisive action, action that will break the vicious circle
of spiraling prices and costs. i am today ordering a freeze on all prices and wages throughout the united states for 90 days. we were having an inflation before the controls resulting from the expectation that inflation would go on. so people were asking for wage increases, and businesses were raising prices in the expectation of inflation. the theory was, if you could stop this process for a while, people would get over that expectation of inflation. a free market could resume with a low inflation rate. but we only created the expectation that when controls ended, prices would zoom again. prices did zoom up again when controls were lifted. price and wage controls proved ineffective in the long run.
even when we took inflation seriously, controlling it was easier said than done. was there anything that could have worked? richard gill offers his commentary. wage and price controls were adopted because the keynesian remedy for inflation-- cutting back aggregate demand-- suddenly seemed inadequate to our new situation. a keynesian-style inflation, we recall, looks like this. demand is too high, so we cut back, say, by raising taxes. we lower prices without having real effect on gnp or employment. suppose our aggregate supply curve is different from the keynesian. suppose the whole supply curve looks like th. suddenly, we're in a new world. prices are too high up here, so we cut back aggregate demand to here.
prices do fall, but-- and this is a huge but-- so, also, does our gnp. to lower inflation, we plunged the economy into a recession. we traded off some of our employment to bring inflation down. these diagrams present an oversimplified picture of what was going on at the time. generally, we can say that by the early 1970s, prices had a tendency to rise before full employment was reached. inflationary pressures were being felt even when there was substantial unemployment in the economy. no wonder economists turned from keynesian to other remedies. sad to say, our problems were just beginning. the late sixties boom had its positive aspects-- lots of jobs and a growing economy-- but the continuing demand pulled up prices.
the spiral of inflation began, and there was no quick fix. once started, it perpetuated itself. we all learned to live with inflation. as we were learning to cope with inflation, it was becoming more complex. by the 1970s, inflation was continuing to grow, but demand fell off and the economy stagnated. stagflation, a problem we'll consider in a future edition of economics usa. this is david schoumacher. captioning made possible by the annenberg/cpb project captioning performed by the national captioning institute, inc. captions copyright 1986 educational film center