A Return to Keynes?
The nomination
of Janet Yellen to become head of the Federal Reserve System has set off a
flurry of media stories. Since she will be the first woman to occupy that
position, we can only hope that this will not mean that any criticism of what
she does will be attributed to sex bias or to a "war on women."
The Federal
Reserve has become such a major player in the American economy that it needs
far more scrutiny and criticism than it has received, regardless of who heads
it.
Ms. Yellen, a
former professor of economics at Berkeley, has openly proclaimed her views on
economic policy, and those views deserve very careful scrutiny. She asks:
"Will capitalist economies operate at full employment in the absence of
routine intervention?" And she answers: "Certainly not."
Janet Yellen
represents the Keynesian economics that once dominated economic theory and
policy like a national religion -- until it encountered two things: Milton
Friedman and the stagflation of the 1970s.
At the height
of the Keynesian influence, it was widely believed that government
policy-makers could choose a judicious trade-off between the inflation rate and
the rate of unemployment. This trade-off was called the Phillips Curve, in
honor of an economist at the London School of Economics.
Professor
Milton Friedman of the University of Chicago attacked the Phillips Curve, both
theoretically and empirically. When Professor Friedman received the Nobel Prize
in economics -- the first of many to go to Chicago economists, who were the
primary critics of Keynesian economics -- it seemed as if the idea of a
trade-off between the inflation rate and the unemployment rate might be laid to
rest.
The ultimate
discrediting of this Phillips Curve theory was the rising inflation and
unemployment, at the same time in the 1970s, in what came to be called
"stagflation" -- a combination of rising inflation and a stagnant
economy with high unemployment.
Nevertheless,
the Keynesian economists have staged a political comeback during the Obama
administration. Janet Yellen's nomination to head the Federal Reserve is the
crowning example of that comeback.
Ms. Yellen
asks: "Do policy-makers have the knowledge and ability to improve
macroeconomic outcomes rather than making matters worse?" And she answers:
"Yes."
The former
economics professor is certainly asking the right questions -- and giving the
wrong answers.
Her first
question, whether free market economies can achieve full employment without
government intervention, is a purely factual question that can be answered from
history. For the first 150 years of the United States, there was no policy of
federal intervention when the economy turned down.
No depression
during all that time was as catastrophic as the Great Depression of the 1930s,
when both the Federal Reserve System and Presidents Herbert Hoover and Franklin
D. Roosevelt intervened in the economy on a massive and unprecedented scale.
Despite the
myth that it was the stock market crash of 1929 that caused the double-digit
unemployment of the 1930s, unemployment never reached double digits in any of
the 12 months that followed the 1929 stock market crash.
Unemployment
peaked at 9 percent in December 1929 and was back down to 6.3 percent by June
1930, when the first major federal intervention took place under Herbert
Hoover. The unemployment decline then reversed, rising to hit double digits six
months later. As Hoover and then FDR continued to intervene, double-digit
unemployment persisted throughout the remainder of the 1930s.
Conversely,
when President Warren G. Harding faced an annual unemployment rate of 11.7
percent in 1921, he did absolutely nothing, except for cutting government
spending.
Keynesian
economists would say that this was exactly the wrong thing to do. History,
however, says that unemployment the following year went down to 6.7 percent --
and, in the year after that, 2.4 percent.
Under Calvin
Coolidge, the ultimate in non-interventionist government, the annual
unemployment rate got down to 1.8 percent. How does the track record of
Keynesian intervention compare to that?
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