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Thinking about a time when government would not just stand back and let the business cycle wreak havoc

Brad DeLong, professor of economics | November 29, 2010

cartoonOne disturbing thing about studying economic history is how things that happen in the present change the past – or at least our understanding of the past. For decades, I have confidently taught my students about the rise of governments that take on responsibility for the state of the economy. But the political reaction to the Great Recession has changed the way we should think about this issue.

Governments before World War I – and even more so before WWII – did not embrace the mission of minimizing unemployment during economic downturns. There were three reasons, all of which vanished by the end of WWII.

First, there was a hard-money lobby: a substantial number of rich, socially influential, and politically powerful people whose investments were overwhelmingly in bonds. They had little personally at stake in high capacity utilization and low unemployment, but a great deal at stake in stable prices. They wanted hard money above everything.

Second, the working classes that were hardest-hit by high unemployment generally did not have the vote. Where they did, they and their representatives had no good way to think about how they could benefit from stimulative government policies to moderate economic downturns, and no way to reach the levers of power in any event.

Third, knowledge about the economy was in its adolescence. Knowledge of how different government policies could affect the overall level of spending was closely held. With the exception of the United States’ free-silver movement, it was not the subject of general political and public intellectual discussion.

All three of these factors vanished between the world wars. At least, that is what I said when I lectured on economic history back in 2007. Today, we have next to no hard-money lobby, almost all investors have substantially diversified portfolios, and nearly everybody suffers mightily when unemployment is high and capacity utilization and spending are low.

Economists today know a great deal more – albeit not as much as we would like – about how monetary, banking, and fiscal policies affect the flow of nominal spending, and their findings are the topic of a great deal of open and deep political and public intellectual discussion. And the working classes all have the vote.

Thus, I would confidently lecture only three short years ago that the days when governments could stand back and let the business cycle wreak havoc were over in the rich world. No such government today, I said, could or would tolerate any prolonged period in which the unemployment rate was kissing 10% and inflation was quiescent without doing something major about it.

I was wrong. That is precisely what is happening.

How did we get here? How can the US have a large political movement – the Tea Party – pushing for the hardest of hard-money policies when there is no hard-money lobby with its wealth on the line? How is it that the unemployed, and those who fear they might be the next wave of unemployed, do not register to vote? Why are politicians not terrified of their displeasure?

Economic questions abound, too. Why are the principles of nominal income determination, which I thought largely settled since 1829, now being questioned? Why is the idea, common to John Maynard Keynes, Milton Friedman, Knut Wicksell, Irving Fisher, and Walter Bagehot alike, that governments must intervene strategically in financial markets to stabilize economy-wide spending now a contested one?

It is now clear that the right-wing opponents to the Obama administration’s policies are not objecting to the use of fiscal measures to stabilize nominal spending. They are, instead, objecting to the very idea that government should try to serve a stabilizing macroeconomic role.

Today, the flow of economy-wide spending is low. Thus, US Federal Reserve Chairman Ben Bernanke is moving to have the Fed boost that flow by changing the mix of privately held assets as it buys government bonds that pay interest in exchange for cash that does not.

That is entirely standard. The only slight difference is that the Fed is buying seven-year Treasury notes rather than three-month Treasury bills. It has no choice: the seven-year notes are the shortest-duration Treasury bonds that now pay interest. The Fed cannot reduce short-term interest rates below zero, so it is attempting via this policy of “quantitative easing” to reduce longer-term interest rates.

Yet America’s right wing objects to this, for reasons that largely remain mysterious: what, at the level of economic theory, is the objection to quantitative easing? Blather about Federal Reserve currency manipulation and excessive risk-taking is not worthy of an answer.

Still, here we are. The working classes can vote, economists understand and publicly discuss nominal income determination, and no influential group stands to benefit from a deeper and more prolonged depression. But the monetarist-Keynesian post-WWII near-consensus, which played such a huge part in making the 60 years from 1945-2005 the most successful period for the global economy ever, may unravel nonetheless.

Cross-posted from Project Syndicate.

Comments to “Thinking about a time when government would not just stand back and let the business cycle wreak havoc

  1. You say “Yet America’s right wing objects to this, for reasons that largely remain mysterious: what, at the level of economic theory, is the objection to quantitative easing? Blather about Federal Reserve currency manipulation and excessive risk-taking is not worthy of an answer”

    Have you actually spent any time doing any research on this? How about the fact we were told we needed a stimulus and Christina Romer herself has admitted the stimulus has failed? Why should we trust the same people who are saying now that we need quantitative easing? This is the worst economy I’ve ever seen in my entire life. I just wish the government would extend the tax cuts, stop the policies that have forced manufacturing jobs to be outsourced overseas and generally get out of lives altogether. This whole mess started because the government said we needed to make loans to people who could not afford them, created the sub prime market and then the Democrats like Barney Frank and Chris Dodd would not listen when regulators warned that things were getting out of hand. Then the stimulus came along and things got even worse. Personally, I just want the government to get out of the way and stop screwing things up for the rest of us. They create a mess then say we need more of the crazy thinking that got us here in the first place. By the way, I’m honored that the Tea Party is being attacked here, it means we must be making some kind of progress.

  2. Brad, let me suggest the following as a working hypothesis: Just as it has been said of Iran that there has been a subtle military coup, and that now the Revolutionary Guards run the show, in the United States, there has been a subtle economic coup, and the country is being run by the upper one percent of wealth holders.

    The incomes of the top one percent are so vast that they can secretly (thanks to the Supreme Court) and publicly buy Congress. An economic aristocracy has been established the likes of which the country has not seen in decades (if ever).

    The Senate, the generals in aristocratic army, no longer have to fight, they just have to hold the line in their own bizarre version of trench warfare. The tea party types are the cannon fodder, the useful idiots who sally forth from the trenches so that the aristocracy can pay even less in taxes.

    The rest of us lurch from port to starboard on the increasingly unstable ship of state with barely enough time to rearrange the deck chairs as we slide by.

    The Fed exhausts itself pushing on its string, and useful fiscal policy seems impossible. In the midst of an unemployment crisis, a freeze on the salaries of federal workers? So much for hope and change.

    Rationality? The new aristocracy don’t need no stinkin’ rationality, they already have more money than that know what to do with. They rest of us can eat cake.

  3. “How did we get here? How can the US have a large political movement – the Tea Party – pushing for the hardest of hard-money policies when there is no hard-money lobby with its wealth on the line? How is it that the unemployed, and those who fear they might be the next wave of unemployed, do not register to vote? Why are politicians not terrified of their displeasure?”

    In the past 10 years there has been an influx of 13 million immigrants but a net loss of 1 million jobs. It requires 2nd grade math, not a PhD in economics, to figure out how to bring down the unemployment rate in the US.

    • Kick out those 13 million immigrants and we’ll have plenty of seasonal agricultural work and hotel maid jobs for everyone. By cracky, I think you’ve got it!

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