Real Fiscal Responsibility 2; Carter: Stagnation and Unemployment

By Joe Firestone

This post continues my series evaluating the fiscal responsibility/irresponsibility of the Governments of the United States (mostly the Congress, the Executive Branch, and the Federal Reserve) by Administration periods beginning in 1977 with the Jimmy Carter period. My first post explained why I chose to start my evaluation with the Carter period, and also laid out my related definitions of fiscal sustainability, and fiscal responsibility.

It explained why fiscal responsibility is closely connected to the idea of public purpose, which I’ve laid out here. I also claimed that the Government of the United States has been fiscally irresponsible in every Administration period since 1977. The remaining posts in this series, and they will be many, will document that claim with analysis.

In this second post, I begin my evaluation of the extent of fiscal responsibility or irresponsibility of the Federal Government during the Carter Administration by covering two of the primary problems reflecting public purpose, and what the Federal Government did or did not do about them with its fiscal and monetary policies. The two are: ending economic stagnation, and creating full employment at a living wage.

Replacing a stagnating economy with one operating at its full potential; closing the current output gap

The economy during the Carter period never operated at full capacity or near full capacity. Deficit and inflation reduction were emphasized above all other domestic concerns, and substantial output gaps were simply accepted as something that it was very difficult for Government to do anything about. This was true during a period in which the presidency and the Congress were both in Democratic hands with substantial majorities.

In addition, the President was able to appoint his choice to head the Federal Reserve on two occasions. During the early part of his Administration he was dealing with a Republican appointee, Arthur F. Burns, who was far from a fiscal hawk on inflation. When Burns resigned, Carter appointed G. William Miller to head the Federal Reserve. Miller was, if anything, more dovish on interest rates than Burns. But later when he moved Miller to Treasury, he appointed the fiscal hawk Paul Volcker as Federal Reserve Chairman, and in doing this shot both himself and the United States economy in the foot; condemning himself to defeat in 1980; and the economy to a multi-year recession with high levels of unemployment from 1980 – 1986.

In spite of his favorable political situation (at least until he appointed Volcker) for active deficit spending-based fiscal policy, President Carter and leaders in the other branches of Government chose to emphasize inflation moderation, rather than facilitating an economy that used its full productive capacity for the public purpose. The outcome of this orientation was characterized as “stagflation” in the popular press, and the term came to stigmatize the Carter period in Government and his Administration, in particular.

Why did the leaders of the Congress, the Executive and the Federal Reserve choose inflation moderation above other goals during the period 1977-1981? Partly because President Carter was very serious about attempting to reduce the Government’s deficit, and eventually balance the Federal budget by 1981, and he implemented a variety of Executive Branch cost-cutting measures across the Federal Government to try to reach his goal, while using the power and bully pulpit of the presidency to bring others along the path of “sacrificing for the public good.”.

Congress both collaborated with and sometimes opposed Carter’s cost-cutting proposals, when they related to infrastructure spending. But generally, they supported him in his broad-based deficit cutting activities, because they bought into the fiscal responsibility as deficit cutting and budget balancing notion, and also accepted that as political virtue in a time of uncertainty and stagflation.

Cost-cutting measures even included the Administration working with Congress to target federal spending based on measuring rural need and urban distress, and using formula-based funding to try to ensure that spending was both efficient and effective relative to the stated objectives of legislation to alleviate distress, need, and poverty. Congress would pass legislation prescribing very general criteria for targeting funds, and then the Administration would supplement the criteria by developing funding formulas allowing for more precise and “rational” allocation of funds.

This effort was aimed at getting the biggest bang for the scarce available “bucks.” It was an admirable, sometimes even idealistic endeavor. But it was also based on the false idea that Federal funds were inherently limited by tax revenues and by borrowing, without any recognition that the Government finance world had changed radically in 1971 when the United States closed the gold window for dollar convertibility.

The President was successful in his deficit reduction activities, his deficits were always under 3% and even got as low as 0.47% of GDP*, even though he never reached his goal of budget balance. But, the Administration had the policy space to deficit spend far more on programs that would have produced a robust economy without producing demand-pull inflation. Nevertheless, the President declined to seriously entertain ideas that called for substantial deficit spending that would have compensated for demand leakage to savings and sometimes foreign trade, because he thought such spending would not be fiscally responsible.

We don’t have good indications of what savings and import desires of the domestic sector were during this period. But we do know that the domestic sector was saving 7.67% of GDP in Federal and State deficits in quarter 2 of 1975 during the Ford Administration, without full employment resulting from this poorly targeted Federal deficit spending, while the CPI was falling from 9.1% to 5.7% of GDP. So, it is likely that the Government could, easily enough, have run at least a 10% of GDP deficit to implement a job guarantee program and create full employment, without creating demand-pull inflation.

Why would the CPI fall during the last year of the Ford Administration even though deficit spending had also been relatively high at the end of that Administration? Simply because the effects of the OPEC oil embargo of 1973-1974 on inflation were receding, and it was these cost-push effects that caused the Nixon-Ford inflation, rather than large Federal deficits creating too much demand.

Creating and maintaining full employment along with implementing the right to a living wage

Though President Carter supported minimum wage increases, he never forcefully advocated for a living wage. He also never proposed or supported a comprehensive job creation program, or the idea of a Federal Job Guarantee, to create full employment, in spite of the fact that he was greeted with a 7.7% unemployment rate (quite high for the post-WWII period up to that time, but down from the high of 8.5% during the Ford Administration), which fell to 5.8% only after three years had passed, and then went back up to 7.1% as he was leaving office.

Carter apparently believed that expensive job programs should not be legislated by the Government, because they were fiscally irresponsible. And his main prescription for reducing unemployment seemed to be tax cuts to provide stimulus and incentives for business, which he alternately proposed and then backed away from when the CPI rose. He also opposed the efforts of many in the Democratic Congress to legislate infrastructure programs, even to the point of using his veto on occasion to block “pork-filled”water resources legislation from passing.

Other than through tax policy, the main effort of the Carter Administration to reduce unemployment came through its expansion of the Comprehensive Employment and Training Act (CETA) program which began during the Nixon/Ford Administration, and was aimed at reducing structural unemployment. The Administration and the Congress increased spending on CETA to $5.6 Billion in 1977; $9.5 Billion in 1978; $9.4 Billion in 1979; and $8.7 Billion in 1980.This level of funding increased the number of public service jobs from 310,000 in 1976 to 725,000 by 1978.

However, when Mr. Carter took office, the unemployment rate was at 7.5%, and the gain in jobs from CETA only made a small dent of roughly one percent in that rate. So looked at in the larger context of the problem the Administration faced, it’s clear that CETA was little more than a band-aid on the wound. And we can perhaps see this even more clearly if we note that CETA spending in 1978 amounted to a little less than 0.4% of US GDP, a pitiful amount if one thinks that the Government had the policy space to run a deficit of at least 10% without creating demand-pull, as opposed to cost-push, inflation.

Next, President Carter’s appointment of Paul Volcker to Chair the Fed was a disaster for people in low wage jobs, since Volcker and his successors used wage rises as a criterion for evaluating whether inflation was accelerating. So, during and after Volcker’s tenure, the Federal Reserve systematically repressed wages by raising its overnight rate targets whenever private sector wages began to rise, and cooling the economy, a policy that may or may not still be somewhere in the background of the Fed’s toolkit under Janet Yellin.

In short, summarizing all of the foregoing, President Carter did not advocate strongly for fiscal policies that would create jobs, and, in addition, he opposed the efforts of many in the Democratic Congress to legislate such programs. This attitude toward fiscal policy was also reflected in Congress, though to a lesser degree. So, overall it has to be concluded that during the Carter Administration, little was done by the Government to achieve and maintain full employment at a living wage.

Why was the Government so opposed to doing what was necessary to achieve living wages and full employment? Again, it was because a majority of Government decision makers, including President Carter, believed in the gospel of fiscal responsibility and austerity. They were incapable of recognizing that they could spend what was necessary to accomplish these goals, even though FDR had shown them what was possible during World War II and part of the Great Depression, and even though they had even more policy space than FDR had to deficit spend, due to the shift to a non-convertible fiat currency, with floating exchange rates, and no debts in foreign currencies, completed by President Nixon in 1971.

My next post will continue the discussion of aspects of the public purpose and what the Government did about them during the Carter period.

*My thanks are due to Professors Scott Fullwiler and Stephanie Kelton for kindly providing me with their quarterly time series data on Sectoral Financial Balances which I’ve drawn upon for the deficit, and GDP numbers I’ve used in this post.

15 Responses to Real Fiscal Responsibility 2; Carter: Stagnation and Unemployment

  1. Joe,
    Where is this number coming from “Government had the policy space to run a deficit of at least 10%?” Just curious how you made the calculation.

    Thanks,
    Tim

    • Sure, Tim. I explained a little bit of my thinking in the text. But basically, the 10% is a guess based on assumptions about the savings and import desires of Americans at that time and the Sectoral Financial Balances (SFB) model. The SFB model says:

      Domestic Private Sector Balance + Domestic Government Sector Balance + Foreign Sector Balance = 0

      The terms refer to balances of flows of financial assets among the three sectors of the economy in any specified period of time. So, for example, when the annual domestic private sector balance is positive, more financial assets are flowing to that sector, taken as a whole, than it is sending to the other two sectors. Similarly, when the annual foreign sector balance is positive, more financial assets are being sent to that sector than it is sending to the other two sectors. When the private sector balance is negative, the private sector is sending more to the other two sectors than it is getting from them, and so on.

      The fact that the SFB model is an identity means that looking at sector balances isn’t enough to infer causality. Yet looking at data measuring these balances can help us analyze causation in the context of other facts.

      But first we have to note that in the normal course of events where trade is loosely managed (“free”), the Government cannot use fiscal policy to control the foreign sector balance, the private sector savings balance, or even the Government deficit, because all three are determined by a variety of complex factors in the economic system. it also can’t control the savings and import desires of the public. However, it can have an effect on these things based on the size and targeting of its deficit spending, or lack of it, implementing its fiscal policy.

      Specifically, if the Government targets deficit reduction, then it can reduce the size of the foreign sector and domestic savings balances, and it can therefore indirectly reduce consumption, sales, employment, and incomes in the private sector, the general level of economic activity, its own tax revenues, and even raise rather than lower its deficits, depending on how the automatic stabilizers (the safety net programs) adjust to the loss of demand caused by Government cutbacks by responding to them with increased spending. So what should the Government do?

      Well, assuming that it doesn’t want to force a negative foreign sector balance (trade surplus) and a positive Government sector balance (budget surplus), resulting in a negative domestic private sector balance, then it must let both the foreign sector and the Government sector balances float with private sector savings desires. This means letting both the trade deficit and the Government deficit grow large enough to accommodate private sector savings and consumption desires.

      Basically, I assumed that private sector savings and import desires if accommodated by Government deficit spending would have amounted to 10% of GDP, so by identity if the Government deficit was allowed to float, the Carter Government could have had a deficit of 10% without causing demand pull inflation, since both the savings and import leakages from the economy would have amounted to that 10%.

      How did I know that would be enough? I didn’t. I just knew that 2 years earlier 7.67% in Federal and State deficits had gone to the private sector and was saved by it without creating full employment. So, 7.67% wasn’t enough to create full employment, but 10% of GDP or more might have been.

  2. Charles Layne

    I sincerely hope a significant number of present day politicians read, understand and appreciate the analysis and comprehension shown in this historical review of the economy.

  3. [email protected]

    Your article fails to address a major issue that you seem to think you can hide under the phrase “demand pull inflation rather than cost push inflation”. Without addressing how Carter should have handled the “cost push inflation”, you leave a big hole in the article. As I remember it, inflation was a major concern for everybody in the years from the end of the Johnson administration to the beginning of the Reagan years. MMT claims that there are no limits to the US government spending as long as it does not bring on inflation. There is some talk under MMT of what to do if inflation should rise. If you ignore this issue when inflation was running rampant, then it feels like MMT is only paying lip service to the worries about inflation.

    I am not saying MMT has no prescription for inflation, but I am saying that if an MMT proponent misses the opportunity to address the inflation issue during a historical period when inflation was rampant, then you give unnecessary ammunition to the people who do not want to believe in MMT and you cut the legs out from under the people who do want to believe in MMT.

    • I didn’t miss the “opportunity.” I just decided that this post would cover two of my 15 or so aspects of public purpose 1) ending stagnation, and 2) creating full employment with a living wage. Creating and Maintaining price stability; i.e. the inflation issue, is another aspect of public purpose, and is covered in my next post.

      Please keep in mind that this a blog series, and that blog posts are not supposed to be long pieces. I’m trying to keep each one to 1500 words or so. So, if you think I’ve missed something,perhaps wait a few posts and then point that out if it’s still an issue.

      • I think it would be a good idea to revise the article to at least say that in a future article you will discuss how to handle cost push inflation. The way it is now, you may be discouraging people to read any further articles. I can hear someone who does not believe in MMT saying, “If he cannot even talk about the issue of inflation as something that had to be dealt with in this historical time period, there is no sense in reading any further. If he thinks that demand pull inflation is all that the responsible fiscal policy has to worry about, then MMT is a failed idea just as I predicted.” I am pretty sure you are not trying to say that at all. The trouble is you may have lost your reader before you get a chance to explain.

        It would be unfortunate if your writing turned people off from the idea of MMT when that was not your intention. You may have well thought out intentions of what you want to write, but sometimes those the way you trying to carry out your intentions have to be put aside when you are made aware that you are not achieving what you hope to with what you are writing.

        Since I do believe in MMT, I will not be discouraged from reading upcoming chapters.

  4. Jame P Savage III

    Joe should have started with the first administration of Lyndon Johnson

    • Different standard of fiscal responsibility applied for Johnson, since he didn’t close the gold window. Nixon did, and so he fundamentally changed the US monetary regime. See the first post in the series.

  5. Your article fails to address a major issue that you seem to think you can hide under the phrase “demand pull inflation rather than cost push inflation”. Without addressing how Carter should have handled the “cost push inflation”, you leave a big hole in the article. As I remember it, inflation was a major concern for everybody in the years from the end of the Johnson administration to the beginning of the Reagan years. MMT claims that there are no limits to the US government spending as long as it does not bring on inflation. There is some talk in descriptions of MMT on what to do if inflation should rise. If you ignore this issue when inflation was running rampant, then it feels like MMT is only paying lip service to the worries about inflation.

    I am not saying MMT has no prescription for inflation, but I am saying that if an MMT proponent misses the opportunity to address the inflation issue during a historical period when inflation was rampant, then you give unnecessary ammunition to the people who do not want to believe in MMT and you cut the legs out from under the people who do want to believe in MMT.

  6. I am beginning to wonder if Joe Firestone takes criticism. All I asked for was a discussion of how fiscally responsible government would handle cost push inflation. Since cost push inflation was mentioned in the article, but there was no explanation of what was a responsible way to handle it.

  7. What is missing (so far anyway) is the rise of OPEC and the first oil embargo and subsequent skyrocketing of oil prices. Although the embargo happened under Nixon/Ford, the price rise was a major driver of inflation, at the same time that Carter’s fiscal policies caused stagnation … surprise … stagflation.

    • There were two price shocks during the 1970s, the OPEC shock during Nixon/Ford, and the Saudi oil shock during Carter’s. They are different events. Prices had begun to decline sharply by 1976 and were only a little higher by the time Carter took office, but then took off again in 1978 because the Saudis, who had become the market leader drove them up. Anyway, stagflation is covered in the next post.

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