The Federal Reserve's War on Inflation

If there was a single theme expressed by Alan Greenspan from late 1987 to early 2006, it was this: “Inflation is a threat to the economy, and the Federal Reserve System is fighting it tooth and nail.” Year after year, for 17 years, Greenspan came before Congressional committees that officially supervise the FED, and he expressed his view. “Inflation is bad. The FED is determined to fight it.”

How bad was inflation when he was sworn in as Chairman of the Board of Governors in late 1987, just before the 508-point one-day fall in the Dow Jones Industrial Average? Mr. Greenspan reminisced a decade later.

The 1987 crash occurred at a time when the American economy was operating with a significant degree of inflationary excess that the fall in market values arguably neutralized.

He then informed the committee’s members of his concern.

Have we moved into a new environment where inflation imbalances no longer threaten the stability and growth of our economy in ways they once did? The simple answer, in our judgment, is no. . . .

Nonetheless, there are early indications that this episode of favorable inflation developments, especially with regard to labor markets, may be drawing to a close. (Testimony before Joint Economic Committee, Oct. 29, 1997)

So, ten years after he took over as Chairman, the United States economy was still facing inflation, meaning price inflation. That was his stated opinion. As far as containing price inflation was concerned, he was implicitly arguing, the Federal Reserve had failed.

The official numbers bore him out. Using the inflation calculator, located on the home page of the Bureau of Labor Statistics, we find that in 1997, an item that had cost $1,000 in 1987 cost $1,412 — a 40% increase in prices.

Fast-forward three years. Greenspan was still sounding the alarm. Inflation had not gone away, and it threatened to go higher.

As I have already noted, to date costs have been held in check by productivity gains. But at the same time, inflation has picked up — even the core measures that do not include energy prices directly. Higher rates of core inflation may mostly reflect the indirect effects of energy prices, but the Federal Reserve will need to be alert to the risks that high levels of resource utilization may put upward pressure on inflation. (Testimony before the House Banking Committee, July, 2000).

It is worth noting that the federal funds rate, which the FED does influence directly, was 6.5% in May, 2000. Over the next three years, Greenspan’s FED pumped in monetary reserves at a rate high enough to force down that rate to 1%.

If we are to believe a career’s worth of official testimony, Alan Greenspan failed to understand the connection between Federal Reserve monetary inflation and price inflation.

In his final official testimony on Capitol Hill, in October, 2005, he was not complacent in the least about inflation. The Federal Reserve was still on the job, monitoring the economy for signs of inflation.

The longer-term prospects for the U.S. economy remain favorable. Structural productivity continues to grow at a firm pace, and rebuilding activity following the hurricanes should boost real GDP growth for a while. More uncertainty, however, surrounds the outlook for inflation. (Testimony before the Joint Economic Committee, Nov. 2005)

Yet there was nothing remotely uncertain about price inflation in 2005. There would be more of it in 2006, just as there had been in 2005, 1995, 1985, and 1915. In Chairman Bernanke’s first year, 2006, the BLS inflation calculator indicates a 3% increase.

Consider the implication of what you have just read. From the day that Alan Greenspan took over as Chairman until the day he departed, he worried about price inflation. His worry was surely legitimate. It took almost $1,800 in 2006 to buy what had cost $1,000 in 1987.

The Federal Reserve System is heralded as the world’s most sophisticated central bank. The U.S. dollar is the world’s reserve currency, meaning that other central bankers trust it in preference to any other national currency. They even prefer holding Treasury bills to holding gold. Yet the Federal Reserve seems unable to solve the problem that Alan Greenspan maintained for 17 years was the fundamental economic problem in the United States: price inflation. Under Greenspan’s administration, as with every Federal Reserve Chairman since the depression year of 1932, prices rose year by year.

Year after year, FED Chairmen have testified to Congress that victory over inflation is just around the corner. Stealing a line from a Robert Benchley theater short from the mid-1930s, “And when I say ‘just around the corner, I mean ‘just . . . around . . . the . . . corner!” Stealing George Goebel’s mid-1950s signature line, “Suuuuure it is!”


Congress has been kept fully informed regarding the progress of the war on inflation. Year after year, Congressmen have sat attentively, listening to testimony from Federal Reserve Chairmen regarding the war against inflation. The message is always the same. “The war on inflation is continuing, but it is not over yet. No, indeed. It continues, and will continue. The Federal Reserve remains diligent. The nation can count on the Federal Reserve!”

This is a war. The enemy is relentless. He never sleeps. But neither do the forces of good.

Unfortunately, the headquarters of the enemy combatants cannot be identified. Like thieves in the night, they keep coming back. They launch attack after attack, month after month. The dollar remains under siege.

No one at the FED seems to know how the enemy does it. Despite overwhelming superiority on the ground, the FED has not brought the war on inflation to an honorable conclusion. It has not driven inflation from the battlefield. The cowardly hit-and-run tactics of the inflationists continue to strike the unarmed citizenry.

This will not stand!

Every FED Chairman has assured Congress: “There is no substitute for victory in the war on inflation. Defeat is not an option.”

When it comes to implementing the correct strategy, each FED Chairman re-thinks the basics when he comes into office. “All options are on the table.” (Except defeat, of course.)

The public should not expect miracles, however. There is no silver bullet. There is surely no golden bullet.

When it comes to the Federal Reserve, each Chairman has fought this war with the army he had available.

Each Chairman has assured Congress that, when it comes to inflation, the enemy is going to be brought in, dead or alive.

Victory is just around the corner.


The minutes of the December 12, 2006 meeting of the Federal Open Market Committee (FOMC), which is widely believed to control interest rates, were released on January 3. The Committee reminded itself that at the October meeting, inflation remained a threat.

Readings on core inflation had been elevated, and the high level of resource utilization had the potential to sustain inflation pressures. However, inflation pressures seemed likely to moderate over time, reflecting reduced impetus from energy prices, contained inflation expectations, and the cumulative effects of monetary policy actions and other factors restraining aggregate demand. Nonetheless, the Committee judged that some inflation risks remained. The extent and timing of any additional firming that might be needed to address these risks would depend on the evolution of the outlook for both inflation and economic growth, as implied by incoming information.

“Some inflation risks remained.” I see. Some. Not too many, but some. In other words, a few. But the committee remained diligent, monitoring data, i.e., “incoming information.”

The problem, it seems to me, is the outgoing information. The committee’s minutes have a familiar ring. They sound amazingly like testimony from Federal Reserve Chairmen down through the years.

This leads me to ask myself: “Are the minutes word-for-word transcriptions? And if they are, where do these people learn to sound exactly like a prepared text before a Congressional committee?” I mean, when were you in a meeting when someone said anything like the following?

However, somewhat weaker-than-anticipated economic data over the intermeeting period apparently led to some softening of investors’ perception of the economic outlook.

Softening? I suppose that is the correct term to describe what is happening to the economy. Soft as in quicksand.

The staff forecast prepared for this meeting indicated that growth in economic activity had slowed to a pace below that of the economy’s long-run potential in the second half of 2006, partly as a result of the ongoing adjustment of the housing sector.

Ah, yes, “the ongoing adjustment of the housing sector.” Homebuilders’ share prices are down anywhere from 40% to 45% since mid-2005. I would call that an adjustment.

Core inflation was anticipated to edge down in 2007 and 2008 in response to a waning of the effects of higher energy and import prices, a step-down in rent increases, and the emergence of a small amount of slack in the economy.

Notice that the committee is operating officially in terms of a cost-push theory of pricing. In 2006, high energy prices pushed up prices in general. So did rent increases.

It seems that every year, new hit-and-run terrorists against the dollar set off their individual IEDs and then disappear. First one, then another appear like masked agents, set off their devices, and flee into the night.

There is no pattern to this terrorism. That is why the Federal Reserve is unable to stamp out inflation, once and for all. It can only react.

Milton Friedman argued that price inflation is always a monetary phenomenon. Ludwig von Mises argued that fractional reserve banking, when protected by a central bank, leads to increases in the money supply, which eventually are followed by rising prices. But the FOMC is not impressed. No, the roots of inflation are far more complex than this simple-minded, monocausational theory of price inflation that blames the central bank for inflation.

Why, if Friedman and Mises were correct, then the free market would be nothing more than a huge auction — an auction at which officials in pin-striped suits carrying buckets full of newly printed money show up, hour after hour, day after day, decade after decade, offering to lend money at below-market rates to the attendees. The bids of these subsidized participants would then keep rising.

Is that all the market is? Why, of course not. It was the buyers’ bidding on energy that drove up prices in 2005. And their bidding on housing. But these bids are now softening. Who knows which bids will push up prices next? The FOMC is monitoring the bidding process carefully. Rest assured that steps are being taken to see which bidders are driving up prices.

So, you can safely ignore the people with buckets full of money. They are simply disinterested observers, trying their best to keep the playing field level.

The economy is now cooling off. But not freezing.

No. Not freezing.

Many participants judged that economic activity in the second half of this year was probably a touch softer than had been expected at the time of the October meeting. But looking over the next year or so, participants continued to expect the economy to expand at a rate close to or a little below the economy’s long-run sustainable pace.

The economy is “a touch softer” than expected. This, according to the committee in charge of soft touches. Nevertheless, despite the signs that the economy’s softness is hardening, inflation still looms.

Although readings on core inflation had improved modestly since the spring, price pressures were not yet viewed as convincingly on a downward trend. Most participants expected core inflation to moderate slowly over time, but stressed that the risks to the inflation outlook remained to the upside.

Got that? There is an upside risk of more price inflation.

All meeting participants remained concerned about the outlook for inflation. Although readings on core inflation had improved modestly since the spring, nearly all participants viewed core inflation as uncomfortably high and stressed the importance of further moderation.

Meanwhile, the FOMC for a year has refused to provide more than a trickle of new reserves to serve as the legal basis of monetary expansion by the banks. The chart of the adjusted monetary base reveals the policy.

This is not a policy of deflation, but it is surely a policy of stable money. If the FOMC sticks to this policy, there will be no more price inflation in the United States over the long haul.

The same thing could have been said in 1914, 1927, 1955, 1971, and 1987.


The minutes reveal that “Participants noted that recent indicators provided mixed signals about the strength of near-term activity.”

I guess this means that some indicators were up. Others were down. Some remained the same.

On this basis, the FOMC decided to leave the federal funds rate alone. Recent data indicate that the FOMC has also decided to leave banking reserves alone.

Now, if we could just be sure that they will maintain this stance: Leave everything alone.

But that is not why commercial bankers persuade politicians to create a government-licensed central bank to control the money supply. Cartels need protection. This is what the Federal Reserve System provides. Whenever I hear the words “Federal Reserve System,” I think “protection money.” Lots and lots of protection money.


What is the FED’s outlook for the economy in 2007?

Less growth but with continuing inflation.

Several members judged that the subdued tone of some incoming indicators meant that the downside risks to economic growth in the near term had increased a little and become a bit more broadly based than previously thought. Nonetheless, all members agreed that the risk that inflation would fail to moderate as desired remained the predominant concern.

If economic growth disappears and inflation remains, we will have returned to the era of stagflation.

Stagflation is politically unacceptable to incumbent politicians.

This is why the FED always returns to monetary inflation. Like a moth drawn to a flame, so are central bankers. They get away with this because short-run politics dominates: the fear of immediate recession rather than the fear of long-term monetary erosion.

The FOMC does not see a recession coming. Yet recessions are always the result of monetary stabilization after a time of monetary expansion. This is the situation today.

The most reliable statistical indicator of a recession is the inverted yield curve, for reasons I discuss here.

We have an inverted yield curve today.

Meanwhile, the FOMC is on the lookout for the next sources of price inflation. It has patrols out on the highways and byways, looking for evidence of inflation.

The members of the FOMC are safe inside the green zone. When you think “FOMC,” think “green zone.”


The FED will continue to fight inflation in 2007, just as it did in 2006, 1996, 1986, and 1916.

There is a famous line: “Fool me once — shame on you.

Fool me twice — shame on me.”

I suggest a revision: “Fool us since 1932 — shame on the voters.”

January6, 2007

Gary North [send him mail] is the author of Mises on Money. Visit He is also the author of a free 19-volume series, An Economic Commentary on the Bible.

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