The Korean War and the Treasury-Fed Accord

On June 25, 1950, North Korean forces crossed the thirty-eighth parallel and attacked South Korea. President Truman responded immediately by authorizing the use of U. S. forces to repel the attack. Less than five years after the end of World War II, the United States found itself at war again.

TABLE 28.1 BUSINESS CYCLES AFTER WORLD WAR II

'From June 1938—the World War II expansion.

Source; The dates and a description of how they are determined are avaiiabie from the Nationai Bureau of Economic Research, "Business Cycie Dates," Http://www. nber. org/cycies/cyciesmain. htmi.

At home, consumers responded by stocking up on items that had been scarce during World War II: sugar, automobile tires, consumer durables, and so on. Inflation accelerated (see Figure 28.1). The government responded swiftly to the threat of inflation; the lesson drawn from World War II was that half-measures don’t work. First, the Revenue Act of

1950, which provided for higher personal and corporate tax rates, was enacted in September 1950. Second, a price freeze was announced in late January 1951. Michael V. DiSalle, the director of the Office of Price Stabilization and a major advocate of a freeze, explained his position this way. Controlling prices was like “bobbing a cat’s tail”—it was better to do it all at once, close to the body; doing it bit by bit produced “a mad cat and a sore tail.”

Third, the Federal Reserve instituted a restrictive monetary policy. During World War II, the Fed pegged interest rates (i. e., placed a ceiling on them). This forced the Fed to purchase more federal debt than it wanted, thus expanding money and credit. Pegging was continued in the early postwar years at the request of the Treasury despite the Fed’s growing resentment. The Korean War brought the conflict into the open. After heated negotiations the Fed and the Treasury announced an agreement on March 4, 1951. It came to be known as the Treasury-Fed Accord because the joint statement issued by the agencies said that they had reached “full accord.” The main point was that the Fed would be allowed to limit its purchase of government debt even if the result was higher interest rates. The Accord permitted the Fed to follow a noninflationary monetary policy during the war; for the entire period of the war, money per unit of real GDP actually fell slightly.

The anti-inflation program worked well. Consumer prices rose at an annual rate of only 2.1 percent from the price freeze in January 1951 to the termination of controls in February 1953. When controls were terminated, many prices were below their ceilings, and no post-control price explosion occurred. As we shall discuss, controls were used again in the 1970s, partly because they had seemed to be such a success in the Korean War. In the 1970s, however, the other parts of the Korean War program—monetary and fiscal restraints—were neglected, and the result was that controls were a failure.