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The Great Inflation and Its Aftermath: The Past and Future of American Affluence
Robert Samuelson
(Random House, 336 pages, $26)

The aftermath of the 1929 stock market crash earned a special name in the history books -- "the Great Depression." In his latest effort, The Great Inflation and Its Aftermath, Robert Samuelson argues that the era of soaring inflation in the 1960s and '70s, though largely forgotten, deserves a similar rank in the annuls of infamy.

Reaching 13 percent in 1979, inflation generated political and economic fallout that goes unappreciated even today. Samuelson argues that it undermined economic stability, caused a prolonged recession, postponed globalization, and even ignited the housing bubble that we see bursting today. But it also swept Ronald Reagan to the presidency.

The villains of Samuelson's story are the economists who, inspired by John Maynard Keynes, ushered into orthodoxy the belief that the economy could be fine-tuned. Paul Samuelson, Robert Solow, and James Tobin -- all Nobel laureates -- believed that the government could keep the economy at "full employment" through constant manipulation of fiscal and monetary policy. Most notably, the Federal Reserve began flooding the market with money anytime the economy seemed under full employment -- which the Fed constantly overestimated. With too much money chasing goods that the economy couldn't produce fast enough, the Fed effectively forced inflation through the demand side.

From Kennedy to Carter, the various presidents took an indirect approach to fighting inflation. Lyndon Johnson quixotically tried to jawbone and bully individual companies into keeping costs low. Nixon betrayed Republicans and instituted wage and price controls. And Carter's attempts at "incomes controls" were both bewilderingly complicated and utterly useless. None had the courage to give America the medicine she obviously needed.

It is easy to forget that Carter, not Ronald Reagan, appointed Paul Volcker as the chairman of the Fed. Indeed, Samuelson explores the unease that characterized their relationship. Volcker's affiliation with Barack Obama today highlights the unlikeliness of the Reagan/Volcker team. The key, Samuelson explains, was their mutual conviction "as a matter of faith" that inflation "was shredding the fabric of the economy and of American society." Reagan, not Carter, had the courage to protect Volcker politically as he ratcheted up interest rates and triggered a severe recession to fight inflation.

Samuelson rejects outright the progressivist narrative that suggests that Reagan was wrong to abandon a Keynesian system in which big government and big corporations' collusion promised full employment. In this narrative, Reagan did achieve price and market stability, but only at the expense of economic security on the personal level. The economic order Reagan bequeathed to us featured decreased job security, outsourcing, and heightened inequality. 

Samuelson's response is that the system that prevailed in the 1960s and '70s has been romanticized beyond recognition. In fact, the engines of growth even in that era had nothing to do with government policies and everything to do with personal risk -- witness the entrepreneurs like Sam Walton and Hewlett and Packard. Samuelson debunks the myths of excess inequality and outsourcing with grace and ease, while also bemoaning that Reagan didn't in fact kill the governmental social net once and for all.

Specifically, Samuelson fears that the American Dream has been co-opted to mean that if we pay our dues, we deserve a comfortable lifestyle.

"Like the early 1960s, then, the spirit of reform is in the air," Samuelson laments, surveying a progressive agenda resembling the Great Society: bolstering the middle class, providing universal health care, punishing corporate greed, and most notably, curbing global warming. These are exact kinds of social projects the Keynesians thought they could accommodate when they initiated the Great Inflation. So Samuelson ends his book on an ominous note -- inflation could once again be just around the corner.

HERE SAMUELSON RUNS HEADLONG into the economic heroes of the hour. Nouriel Roubini of NYU, dubbed "Dr. Doom" for his prescient predictions of the current crisis, forecasts stag-deflation -- a reprise of the Great Depression. He formulates that aggregate demand will slump in a recession, leading to an excess of supply, especially in over-invested economies like China. High supply and low demand means lowered prices and deflation. All the economic indicators -- the TIPS spread and commodity prices especially -- corroborate Roubini.

But Samuelson's thesis is based not on indicators, but on history. The market conditions in the postwar period didn't foreshadow inflation. Instead, an unholy alliance of politicians and smug economists intentionally ignited inflation -- "[the Great Inflation's] continuing significance is that it was a self-inflicted wound: something we did to ourselves with the best of intention and on the most impeccable of advice."

The danger -- the real danger -- our economy faces is inflation and a prolonged malaise, not deflation and a brief depression. Roubini argues that the current bailout and liquidity measures by the Fed aren't inflationary because the market demands liquidity, and the government can finance its actions with debt, as opposed to monetizing the deficits with inflation. But inflation as a policy tool will start looking mighty tempting in the face of political pressure to finance the bailout, pass a stimulus, increase liquidity, implement new programs, and avoid tax hikes. True, Ben Bernanke, the current Fed chief, was heralded at his nomination as an "inflation fighter," but central bank independence fell by the wayside during the bailout as Treasury Secretary Paulson and President Bush had their way with the Fed.

In the end it comes down to whether one trusts the government to disregard economists who would "fine-tune" and to limit its own social-engineering enterprises. As Samuelson's history demonstrates, such trust would be misplaced.