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Lotterman: Political pressure can send Fed astray

History repeatedly has demonstrated repeatedly that when a nation's money supply is subordinated to politics, inflation results and society suffers.

The United States structured the Federal Reserve to minimize political tinkering. But elected officials still pressure Fed decision-makers to manipulate the economy for electoral advantage. Such pressure can be extreme.

That is the lesson in an article by University of Delaware economist Burton Abrams in the fall 2006 edition of the Journal of Economic Perspectives. Abrams examines the famous tape recordings of Richard Nixon's conversations and telephone calls to see if and how Nixon tried to influence then-Fed Chairman Arthur Burns.

The issue is not new. The Fed's Open Market Committee increased the money supply to lower interest rates in late 1971 and early 1972. The timing was such that any resulting economic stimulus would occur in the heat of the 1972 election campaign. Lower unemployment and growing output would benefit Nixon, the incumbent seeking re-election.

Unfortunately, inflation already was a problem. In 1970, the Consumer Price Index rose 5.3 percent. In response, Nixon imposed wage-price controls in August 1971, outraging Milton Friedman and many other economists who historically favored Republicans.

Imposing wage-price controls and then boosting the money supply is like wrapping a stove in insulation and then opening the draft. The heat gets intense but you can't notice it right away.

History is clear. The Fed did goose the money supply. Unemployment did fall in the run-up to the 1972 election. Nixon was re-elected.

Inflation was only 3.6 percent in 1972 but rose to 9.6 percent in 1973 and 11.8 percent in 1974. It persisted until after President Jimmy Carter appointed Paul Volcker to chair the Fed in late 1979.

Critics questioned Burns' actions almost immediately. He went to his death in 1987 insisting that he had not favored Nixon's re-election in any way. But the historical record suggests that Burns was either dishonest or incompetent. There is no other good explanation.

Professor Abrams' article does not settle that question. What he does establish is how directly, frequently and cynically Nixon and his advisors pressured Burns.

Abrams examines seven taped conversations between October 1971 and September 1972. In some, Nixon directly cajoles Burns. In others, he discusses with his advisers, especially budget director George Schultz, how to manipulate the Fed chairman.

Abrams concludes, "Regardless of the ultimate source of Arthur Burns's motivation, his actions as Federal Reserve chair helped to trigger an extremely costly inflationary boom-bust cycle."

He argues the incident "illustrates the danger of permitting too much discretion in the implementation of monetary policy. It is time to consider an explicit rule for monetary policy."

A monetary rule was Milton Friedman's prescription for decades and continues as a mainstay of Monetarist and Rational Expectations thought. Not all economists will agree, but Abrams' research is a chilling reminder of the dangers of political influence on the Fed.

Economist Edward Lotterman teaches and writes in St. Paul, Minnesota. Write him at ed@edlotterman.com

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