In the late 1950s it dawned on the world that inflation — for the first time in history — had become a chronic, permanent peacetime condition. The puzzle that was on the minds of economists and policy makers worldwide was why. In an August 1957 article headlined “Basic Inquiry Into a Baffling Inflation,” New York Times economics correspondent Edwin Dale anatomized the ongoing debate among experts as a clash between two camps: what Dale termed the “Classicists” and the “New Inflationists.”
The Classicists believed that “the present inflation is not really peculiar, that it is caused by the same thing that has always caused inflation — too much money chasing the available supply of goods and services — and that the cure for it is tight money.” The New Inflationists, in contrast, contended that “this is something relatively new under the sun,” and that it stemmed from certain basic changes in the workings of capitalism: as Dale put it, changes in “the powers and practices of business (particularly big business) and labor (particularly organized labor).”
The New Inflationists were, of course, those who embraced the new view of inflation advanced by John Maynard Keynes and his Cambridge disciples. (Though some New Inflationists were pur jus believers in Keynes’s theory, most were not, so I’ll refer to the broader, heteroclite camp as “neo-Keynesian.”)
The neo-Keynesians’ analysis of “the new inflation” was grounded in Keynes’s cost of production–based theory inflation, in which the wage rate (relative to labor productivity) was seen as the key determinant of the price level. When that theory was joined to Keynes’s empirical observation that “in the modern world of organized trade unions and a proletarian electorate,” resistance to disinflation was “overwhelmingly strong,” the conclusion followed logically: trying to stop inflation by squeezing aggregate demand with high interest rates or government spending cuts could be effective only if the remedy were applied in such massive doses as to raise unemployment to wage-depressing levels that were — in the postwar world — politically infeasible, whatever one thought of their morality.
The distinctively “Keynesian” alternative remedy for postwar inflation was, instead, what became known as “incomes policy,” a catchall term for any initiative — whether a government policy or a set of private agreements — aiming to intervene directly in the wage- and price-setting process, to deter or countermand inflationary behavior.
The logic of incomes policy flowed from the understanding that a wage-price spiral, like an arms race, is a collective action problem: a situation in which behavior that is individually rational is, in the aggregate, collectively ruinous. It’s in no one’s interest to force up their own wages (or prices) if doing so merely induces others to do the same, wiping out any initial advantage gained. In such a situation, everyone is forced to run faster just to stay in the same place.
In 1925, when the success of Britain’s post–World War I economic policy had hinged on getting the price level down, Keynes had proposed, as an alternative to Winston Churchill’s brutal deflation, a “National Treaty” in which trade unions, employers, and others would mutually agree to accept a reduction in their money incomes by some flat percentage. But the scheme never saw the light of day, at least not in interwar Britain.
After the war, however, incomes policies along similar conceptual lines, though in disparate forms, proliferated throughout the world. Every industrialized country (and many others), faced with the novel problem of chronic peacetime inflation, turned to some form of “wage-price policy” — a now-forgotten subject that once occupied the attention of vast swathes of governmental and academic machinery in every major world capital.
For decades, the wage-price issue filled the newspapers daily with tortuous, dry-as-dust chronicles of pay advisory councils and labor-management accords, and spawned countless scholarly conferences and cabinet white papers. (Today, the New York Public Library catalog contains more items under the antiquarian subject heading “wage-price policy” than under “Robert F. Kennedy” or “Harry S Truman” — topics that some people, at least, still find interesting.)
The most successful postwar incomes policies were those that were embedded in the wage-bargaining practices of countries, like Sweden or Austria, that had relatively centralized and cohesive trade union movements. Union centralization (or coordination) offered a means of solving the collective action problem inherent in a wage-price spiral: in essence, the unions made a pact with one another to refrain from fully exploiting opportunities to force up their wages too far beyond some guideline annual percentage based on the trend rate of labor productivity growth.
Countries that were able to make use of such mechanisms consistently enjoyed more favorable inflation-unemployment trade-offs than countries that lacked those institutional prerequisites. Thus, a country like Sweden, with its highly centralized LO trade union federation, experienced lower inflation for any given level of unemployment than countries like the United States or Britain — where the labor movement was, as Joan Robinson put it in a 1958 lecture, “like most of our institutions . . . a tangled natural growth which obstinately resists being combed and clipped into any neat arrangement.”
But even under the most favorable circumstances, incomes policies of this kind suffered from an acute internal contradiction: they required trade unions to deliberately forego opportunities to secure higher wages for their members. This was a course that not only went against the deepest instincts of union leaders, but seemingly called into question the basic purpose of trade unionism itself. Union-based incomes policies thus threatened to undermine the unions’ very legitimacy in the eyes of their own members.
From Theory to Shock
Arrayed against the neo-Keynesian New Inflationists were those whom Dale called the Classicists. By the late 1960s this camp would acquire the more familiar moniker by which its members are known today: “monetarists.” In the 1950s, they were the embattled loyalists who still clung to some version of the old Quantity Theory of Money that Keynes had done so much to discredit in the General Theory.
Though the ranks of these Classicists had been dwindling for twenty years, their ideas would soon receive a new lease on life thanks to the work of a still-obscure scholar — his name appears nowhere in Dale’s article — who in just a few years’ time would emerge as one of the twentieth century’s most consequential intellectuals: Milton Friedman.
Friedman’s great intellectual project in the 1950s was his effort to revive the quantity theory of money, an aim he pursued in works like “The Quantity Theory of Money: A Restatement,” which was published (alongside other essays by Chicago School economists) in Studies in the Quantity Theory of Money (1956).
Though the theory had fallen deeply out of fashion in the economics profession since the 1930s, it had quietly survived and developed — or so Friedman claimed — as an “oral tradition,” passed down in seminars and tutorials from one generation of professors and graduate students to the next within the University of Chicago economics department, where Friedman had earned his master’s degree and had now been teaching for a decade.
The quantity theory was more than just a technical analysis of the price level. It gave analytical shape to a broader ideological view, lying at the core of nineteenth-century laissez-faire liberalism, that blamed mismanagement of the monetary system — a natural monopoly that was almost inherently public in its institutional structure — for all significant macroeconomic dysfunctions arising in what was otherwise a harmonious and efficient system of private, market capitalism.
Only when this ideological vision is understood does it become possible to make sense of a fact that would otherwise seem baffling and bizarre from today’s vantage point: that in the “great debate” over inflation that took place in the United States in the 1950s, 1960s, and 1970s, it was Milton Friedman and his free-market followers who went out of their way to exonerate trade unions and the labor movement from any causal role in generating higher inflation, while the most left-wing Keynesians, including Robinson and her close friend John Kenneth Galbraith, unwaveringly insisted on the central role of collective bargaining in producing a chronic inflationary dynamic.
In the ideological vision that lay behind the quantity theory, the private economy was a source of macroeconomic stability and efficiency, while all serious disturbances to the harmonious workings of capitalism came from policies of either too much or too little money creation by a blundering central bank.
Advocates of laissez-faire regarded trade unions as efficiency-destroying monopolies. But to admit that the market behavior of private actors — even actors that behaved monopolistically — could cause systemic dysfunctions like inflation or recession would amount to an indictment of free markets and open the door to a justification for systematic state intervention.
Thus, in the mid-1970s Friedman lamented that “In Britain, the explanation that everybody gives for inflation is that inflation is caused by trade unions, the greedy grasping laborers who force up the wages that cause inflation.” He was “dismayed,” he said after a visit to London, at “the widespread support of ‘union bashing’ as a way to attack inflation.”
As for the other side of the debate, Keynes’s cost-based theory of inflation — which regarded excessive wage growth as the prime cause of durable inflation — flowed naturally from a realistic analysis of how prices are actually set in a market economy. But for Robinson, there was a political meaning behind the factual analysis. As she put it in a 1958 lecture:
The trade unions are not an alien element in capitalism but an absolutely necessary part of its mechanism. Trade union pressure which counters monopolistic tendencies and keeps profit margins in check is necessary in order to make it possible for profits to be realized. A strong labour movement is required to rescue capitalism from its ‘internal contradictions’. But if it is strong enough to do so, it is liable to be too strong, and to make a chronic vicious spiral.
This is the dilemma which twelve years of high employment has revealed. Some observers draw the conclusion that full employment with a stable value of money is unattainable, and that the only possible policy is to keep a sufficient margin of unemployment to discipline the unions, and a sufficiently slack market to make employers anxious to avoid raising costs. They would be content with a mild rate of progress in real production in order to enjoy the benefit of a stable or rising value of money. Those who support this kind of view are generally of the most respectable and conservative kind, but they seem to me to be making propaganda for Communism. They seem to agree with the Marxists that capitalism cannot preserve employment and that it has reached the stage of being a fetter upon progress.
A decade later, the conservative and respectable Milton Friedman would revolutionize macroeconomics by formalizing a version of this idea — the idea of a necessary “margin of unemployment” — in his theory of a “natural rate of unemployment.”
That theory did, in fact, converge with the thinking of many Marxist economists of the 1960s and 1970s. But its most important adherents have always been central bankers like Paul Volcker or Jerome Powell, for whom it has provided an academically respectable justification for policies aimed squarely at putting a lid on the power of the working class.