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A Grim History Repeats at the Fed

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Farmers descended on Washington to protest high interest rates in 1979.
Charles Harrity/AP/Shutterstock

About the author: Robert Heller is a former member of the Federal Reserve Board of Governors.

As Milton Freedman said in 1970, “Inflation is always and everywhere a monetary phenomenon.” Little has changed since then.

For most of the 1970s, Arthur Burns was chairman of the Federal Reserve Board. Inflation was rampant, just like now. Consumer price inflation averaged nearly 7% during his term. As Friedman diagnosed correctly, this rapid inflation was mainly caused by increases in the money supply of over 12% in the years 1971-72 and 1976-77. Instead, Burns attributed the price increases mainly to wage pressures, monopoly power, and the oil shock of the early 1970s.

Sound familiar? Inflation is again soaring, and the Fed blames supply constraints caused by the pandemic while neglecting to look at the increasing money supply as the main cause. It’s always easier to blame external factors rather than something that you control and have responsibility for.

I had the honor of serving under Chairman Paul Volcker on the Federal Reserve Board starting in 1986, when he was trying to bring inflation under control. President Jimmy Carter had appointed Volcker in August 1979 with the mandate to reduce the double-digit inflation rate. President Ronald Reagan confirmed this objective after he took office. With determination, Volcker raised the federal-funds rate to 20% by June 1981 and reduced the growth of the money supply. Not one, but two back-to-back recessions resulted.

The situation in Washington was tense while the monetary policy medicine took its course. But Volcker and the board prevailed and reduced the annual growth rate of the money supply from over 12.6% in 1979 to a much more reasonable 5.3% when he left the Fed in August 1987. Alan Greenspan continued the anti-inflationary policies. By the time I left the board in 1989, consumer price increases had moderated to only 4.6%.

The Fed was on its way to defeating inflation and keeping it under control for the rest of the century. The falling interest rates that accompanied the decline in inflation were a welcome side effect. These low rates supported decades of growth and prosperity.

Fast forward to 2020. In response to the sharpest recession in U.S. history, the government instituted unprecedented fiscal stimulus measures that sharply increased the federal deficit. The Federal Reserve supported these fiscal actions by buying up much of the newly issued debt. As a result, the ratio of debt to gross domestic product reached a record 136%, while the M2 money supply skyrocketed from $15 trillion in January 2020 to $21 trillion in November 2021.

Largely unrelated to the pandemic, but occurring at the same time, the Federal Reserve implemented a significant change in its operating procedures and long-term strategy. After extensive deliberations, the Fed revised its “Statement on Longer-Run Goals and Monetary Policy Strategy” in August 2020. In it, the Fed essentially tossed the congressional mandate for “price stability” or zero inflation overboard and reaffirmed its target of 2% for the Personal Consumption Expenditures Price index. It added the explicit proviso that periods of sub-2% inflation should be compensated by periods of above-2% price increases. Amazingly, the words “money” or “money supply” are nowhere to be found in this statement on monetary-policy strategy.

This change in strategy opened the gates for an excessively expansive monetary policy after a decade of rather subdued inflation. When the pandemic hit, the Fed engaged in massive quantitative easing through the purchase of Treasury bonds and mortgage-backed securities that resulted in 25% money growth. These actions were flanked by direct lending by the Fed to the public under a dozen Section 13(3) facilities.

Just as Friedman predicted, prices reacted with a lag. At the end of 2021, producer prices were soaring at a rate of nearly 10% and consumer prices were rising at over 7% year over year.

At the beginning of 2022, inflation is again running at full steam. However, the Fed is still pursuing a highly accommodative monetary policy by buying billions of Treasuries and mortgage-backed securities every month. How does it make sense to buy these instruments, while housing prices are exploding at an annual clip of nearly 20%? In addition, the Fed is still holding its foot on the gas pedal by maintaining the fed-funds rate at essentially zero. The Fed continues to provide more fuel for an already soaring inflation.

Even more disconcerting may be the fact that during the past two years, the Fed not even once mentioned the word “money” in its official press releases at the conclusion of each Federal Open Market Committee meeting. One must ask how an institution charged with the control and implementation of monetary policy can be so negligent and dismissive of the key asset—money—over which it exercises total control, and which is at the fulcrum of the implementation of monetary policy. How long does it take to change an irrational policy that is clearly inconsistent with the congressional mandate for price stability?

Just like Arthur Burns, the current Fed leadership is ignoring the sharp increase in the money supply during the past two years and instead is blaming external factors. As a result, inflation is again soaring. History is repeating itself.

Milton Friedman will be turning in his grave.

Guest commentaries like this one are written by authors outside the Barron’s and MarketWatch newsroom. They reflect the perspective and opinions of the authors. Submit commentary proposals and other feedback to

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