"I want to lower inflation without raising unemployment, but they tell me it's impossible. How do I do it?"
The dialogue occurred between Richard Nixon, candidate for U.S. president, and economist Edmund Phelps in 1968. Decades later Phelps would be a Nobel laureate in economics and recalls that exchange in the Oval Office in his new memoir My Travels in Economic Theory.
Trained and accustomed to speaking in classrooms and audiences, Phelps confessed in his work that at that moment it was not easy for him to react. "That whole room full of people looking at me was not the place to convey my thoughts."
Inflation and unemployment are a difficult and sensitive marriage for governments. It does not matter their political sign or their condition of origin or legitimacy.
"The military was terrified of recession," José Martínez de Hoz, the economy minister of the last dictatorship, once said. "They saw an unemployed person as a potential guerrilla."
The Army and Navy asked Martínez de Hoz for something similar to Nixon's proposal to Phelps: lower inflation from three digits annually to double digits by the end of the administration, but with the condition of not "losing full employment," an expression that economists use to refer to when unemployment is frictional. that is, temporarily unemployed people, entering and leaving the labor market.
Thus, in the time of the military, the idea of curbing inflation through mini-devaluations and adjustments in relative prices (La Tablita) was chosen instead of the classic orthodox recipe of adjusting the interest rate and cooling the economy by pushing unemployment upwards.
The latter had a name in economics and was the terror of many leaders.
In 1958 Arthur Phillips, a professor at the London School of Economics, published a study on the behavior of wages in Britain between 1861 and 1957. The Phillips curve is an inverse relationship between the unemployment rate and the growth rate of wage inflation.
The finding quickly became a key piece of macroeconomic policy analysis. Politicians and economists believed that one could choose between different combinations of unemployment and inflation rates. For example, having a low level of unemployment as long as they were willing to accept high inflation as in the sixties in Argentina and the world.
But the Phillips curve wouldn't work well in the '70s and '80s. Nobel laureates in economics Milton Friedman and Phelps himself argued that, sooner or later, unemployment in an economy converges to an equilibrium level regardless of inflation. Workers are not fools, they are interested in the real wage, not the nominal one.
In the book The Hour of the Economists (Binyamin Appelbaum) it is said that also in 1968 Nixon told his advisers (the same year he met with Phelps) that an election is not lost because of inflation. "People are more concerned about unemployment than the supermarket." Or that the Federal German Economy Minister, Helmut Schmidt, told Germans that they could cope better with 5% inflation than 5% unemployment despite the memory of the hyperinflation of the 20s.
When he finally became president, Nixon appointed Arthur Burns, an economist he trusted, to head the Federal Reserve, pressuring him to issue money to stimulate employment. "He will always err on the side of inflation," Nixon said.
The president was also advised by Friedman and Alan Greenspan, two ultra-Orthodox economists. But he never cared much about what he was told, as read in The Man Who Knew, about the life of Greenspan (Sebastian Mallaby).
Nixon replaced William McChesney Martin in the Fed, whom he always blamed for losing the 1960 election by raising rates before the election, and then appointed Burns instead.
Nixon summoned the new chairman in the Oval Office.
"My relationship with the Federal Reserve will be different than it was with Bill Martin," Nixon began with Burns. "I'm telling you now, Arthur, keep us out of recession and unemployment."
"Yes, Mr. President," Burns replied, lighting his pipe.
Nixon continued, "The Federal Reserve and the supply of money and bills are more important than the Treasury and the Budget."
"Arthur, I want you to come and see me privately at any time."
"Thank you, Mr. President."
Years later, both the Labour Party in Britain and the Democrats in the US would lose the election, in part, because of high inflation and then because they tried to curb price increases with price controls. Inflation would be curbed, however, with what no leader wanted: high unemployment.