This Era May Come to Be Remembered as the Federal Reserve’s Third Great Mistake

The success of the Federal Reserve System is apparent today…These [recent] events are deplorable, but they were of course inevitable and could not have been avoided.

- Charles Hamlin, Federal Reserve Board Governor, November 8, 1929

While the Federal Reserve would always accommodate the Treasury up to a point, the charge could be made – and was being made – that the System had accommodated the Treasury to an excessive degree. Although [Chairman Burns] was not a monetarist, he found a basic and inescapable truth in the monetarist position that inflation could not have persisted over a long period of time without a highly accommodative monetary policy.

- FOMC Meeting Minutes, March 9, 1974

The inflation rate over the longer run is primarily determined by monetary policy, and hence the Committee has the ability to specify a longer-run goal for inflation… In order to anchor longer-term inflation expectations at this [2%] level, the Committee seeks to achieve inflation that averages 2 percent over time, and therefore judges that, following periods when inflation has been running persistently below 2 percent, appropriate monetary policy will likely aim to achieve inflation moderately above 2 percent for some time.

- Statement on Longer-Run Goals and Monetary Policy Strategy, FOMC, August 27, 2020

The Great Inflation of the 1960s and 70s, the earliest stages of which were already underway when Graham spoke at the St. Francis Hotel, eventually produced some of the most astonishing economic dislocations in U.S. history. After 1963, there would be a parabolic increase in consumer prices, leaving the Consumer Price Index at three times its former level. Commodity prices would also triple. Near the end of the most rapid phase of that increase in prices, interest rates would reach the highest levels in U.S. history, and risk assets would sink to the lowest valuations in fifty years.

Yet as the earliest stages of the monetary expansion were underway in late 1963, none of the oncoming inflation of prices was reflected in the markets. Interest rates were low and stable, and valuations of risk assets were high and still rising. Though the impacts of rising inflation represented risks which were embedded in the prices and valuations at the time, the long process of pricing in those risks lay ahead.

Within the Federal Reserve System, the inflation which plagued the U.S. in the 1970s is known as the Second Great Mistake. The primary reason it is known as a mistake is because many of those within the Fed at the time understood the inflationary implications of the policies which were being enacted, but monetary policy traveled down that road anyway. It remains a case study of an institution that lost sight of its long-term goals while reacting to short-term problems. At every step along the road to higher inflation, the costs of prioritizing long-term price stability over the economic and market conditions at the time were, again and again, deemed too high.