On its face, the historical backdrop does not imply that the central bank was less independent. Yet, Allan H. Meltzer’s work shows that compromised independence was not just one of many contributing factors but, in his view, the key source of the persistent high inflation from the mid-1960s to the end of the 1970s.
In his paper “Origins of the Great Inflation”, Meltzer argues that the policy errors of the 1960s and 1970s arose from several interlocking factors. He highlights three in particular:
Leadership style. Chairman William Martin’s insistence on consensus within the FOMC delayed prompt anti-inflationary action and allowed inflation to gain momentum.
Flawed analytical frameworks. Policymakers downplayed the monetary roots of inflation, treating price rises as transitory and not requiring forceful responses.
Compromised independence. Institutional arrangements that promoted fiscal–monetary coordination undermined the Fed’s autonomy. Meltzer contends that this political influence, internalised by both Martin (who was the head of the Board of Governors until 1970) and Arthur Burns (who took over after Martin in 1970), was arguably the most significant factor preventing timely and effective disinflation.
These themes are visible in the FOMC’s own discussions. A clear early example comes from December 1965, when the Committee debated whether to tighten policy as inflation began to rise.
In this discussion, members openly debated how to adjust policy without colliding with the Administration. Chairman Martin wanted to raise interest rates but, fearing for the System’s independence if it acted against the President’s wishes, hesitated: ‘There is a question whether the Federal Reserve is to be run by the administration in office.’
This is in itself a remarkable statement: Should the Fed act in a way that wasn’t in the interest of the administration, Martin feared that the Fed would be taken over by the administration. This fear made it more difficult for him to act in a way he believed to be right (by raising interest rates).
Other members also had reservations against tightening the monetary policy stance. Three out of seven members voted against: Robertson, Mitchell and Maisel.
Robertson argued that inflation was not inevitable and warned that higher rates might trigger a recession and raise Treasury borrowing costs. Mitchell opposed an increase on political grounds, noting that the Fed “appeared to be on a collision course with the administration” and preferring to negotiate with the Administration on how to raise rates. Maisel’s main concern was the recovery, but he also believed they should wait for the President’s budget in mid-January before adjusting rates. He favoured incomes policy to control prices and wages: “A discount rate increase … could be interpreted only as a vote of no-confidence by this Board in the national goal of growth at full employment.” If inflation rose, he argued, the Board could act later.
When the Fed implemented higher interest rates, it accompanied the move with a statement saying it had “no intention of imposing a severe ‘tight money’ policy that would render bank loans difficult to get.”
President Johnson criticised the decision publicly, saying it would hurt consumers and state and local governments and complaining that “the decision on interest rates should be a coordinated policy decision in January.” Interestingly, the New York Times editorial supported the President on coordination while recognising that inflationary pressures had increased.
This exchange shows how concerns about co-ordinating with the White House, protecting Treasury borrowing costs and maintaining “full employment” shaped the Board’s willingness to act on inflation, exactly the dynamic Meltzer identified.
The desire to coordinate with the administration continued throughout the 1960s, and the Fed was not able to stem the rise in consumer price growth. Inflation moved from slightly less than 2% YOY at the end of 1965 to 4.7% in late 1968 and further up to 5.9% at the end of 1969. Even as this happened, the FOMC framed its decisions in the shadow of fiscal policy and Treasury financing. The December 1969 transcripts notes that operations were directed at maintaining firm money-market conditions “while taking account of strains in the Treasury bill market,” and repeatedly cites uncertainty about “the extent to which fiscal policy might be relaxed.” Although less explicit than in 1965, these transcripts show that the Fed still weighed government financing needs and fiscal developments heavily in its deliberations, a subtler form of policy coordination that hindered its ability to act independently.