A Key Quote from Samuelson and Solow (1960)

The full thought, from section IV of Samuelson and Solow (1960):

"If by deliberate policy one engineered a sizable reduction of demand or refused to permit the increase in demand that would be needed to preserve high employment, one would have an experiment that could hope to distinguish between the validity of the demand-pull and the cost-push theory as we would operationally reformulate those theories."

I have to go back and check what they mean by "as we would operationally reformulate those theories", but Paul Volcker performed that experiment as Chairman of the Federal Reserve. Marcus Nunes writes:

On becoming chairman of the Fed, Volker challenged the Keynesian orthodoxy which held that the high unemployment high inflation combination of the 1970´s demonstrated that inflation arose from cost-push and supply shocks – a situation dubbed “stagflation”...

To Volker, the policy adopted by the FOMC “rests on a simple premise, documented by centuries of experience, that the inflation process is ultimately related to excessive growth in money and credit”.

This view, an overhaul of Fed doctrine, implicitly accepts that rising inflation is caused by “demand-pull” or excess aggregate demand or nominal spending.

Josh Hendrickson concurs:

... Relying on public statements and personal diary entries from Arthur Burns, I demonstrate that there is little evidence that the Federal Reserve was less concerned with inflation during the 1970s. Rather, the view of Burns and others was that inflation was largely a cost-push phenomenon. Burns thought that incomes policies were necessary to restore price stability and stated that “monetary and fiscal tools are inadequate for dealing with sources of price inflation that are plaguing us now.”

The shift in policy, beginning with Paul Volcker, was an explicit attempt to stabilize inflation expectations and this was done deliberately at first through monetary targeting and ultimately through the stabilization of nominal income growth. Gone were notions of cost-push versus demand-pull inflation. The Fed simply assumed accountability as the creator of inflation.

The Fed limited the growth of the quantity of money and limited the growth of nominal income. Volcker ran the experiment. Gone was the notion of cost-push versus demand-pull. Volcker implicitly accepted that rising inflation was caused by “demand-pull”.

Even before the experiment was over, cost-push was no longer considered valid theory. That was Volcker's premise. Today, the cost-push idea is taken as some kind of joke -- or quaint, perhaps, but definitely wrong. In comments on Hendrickson's post, Nick Rowe quoted the part about Burns thinking inflation was largely a cost-push phenomenon. and replied:

People forget (and maybe younger people never knew) just how common that view was in the 1970’s. It was common among economists as well as the general population. It was almost the orthodoxy of the time, IIRC. Tighter monetary policy would just raise interest rates, which would increase costs, and make inflation even worse.

Hendrickson agreed with Rowe. Nunes agreed with Hendrickson's post. And Bill Woolsey wrote:

There were really _economists_ who thought that “tighter money” would raise inflation through a cost-push mechanism?

I got in on the action and responded with a yup to Woolsey, quoting Robert V. Roosa, past vice president of the New York Fed, and Undersecretary for Monetary Affairs under President John F. Kennedy. Roosa, from Fortune magazine, September 1971:

And yet another factor has been the undue reliance on restrictive monetary policy to limit demand, with the perverse result of making interest rates themselves a major cost-push force.

Roosa's kind of thinking has been almost universally dismissed by economists. That dismissal is a case where the old ideas ramify into every corner of our minds.

In the US, in 1952, interest costs amounted to 5.67% of GDP, a pretty low number. Sixty years later in 2012, interest costs came to 15.42% of GDP. That's a difference of almost ten percent of GDP. If our reliance on credit hadn't increased, and our interest costs still amounted to 5.67% of GDP, prices could have been almost 10% lower than they actually were in 2012 -- with the difference not involving wages, but only interest costs.

Oh by the way: in 1952 the effective interest rate in the US was 4.35%. In 2012 that rate was 4.36%. Almost identical. (That's why I picked the years 1952 and 2012.) The interest rate was the same, but the interest cost was $160 billion more in 2012 than 1952. Why? Because there was more debt in 2012. A lot more debt.