After President-Elect Obama named his bench of economic advisors, the ghost of John Maynard Keynes seems to have been resurrected to guide the new administration’s policies in response to the worst economic crisis we have experienced since 1929.
On the surface of things, Keynesian policy makes eminent sense, doesn’t it? Indeed, Franklin Delano Roosevelt invoked Keynes almost exclusively in devising the New Deal to combat the economic depression of the time. Creating programs such as the Civilian Conservation Corps (CCC) and the Works Progress Administration (WPA), the federal government became the “employer of last resort” Over the next decade, businesses often perceived themselves to be under assault by Roosevelt’s economic policies. Even within the administration, internal differences were epitomized by Treasury Secretary, Henry Morgenthau, who was intensely uncomfortable with FDR’s Keynesian approach. In May 1939, Morgenthau wrote in his diary:
"We have tried spending money. We are spending more than we have ever spent before and it does not work. And I have just one interest, and now if I am wrong somebody else can have my job. I want to see this country prosper. I want to see people get a job. I want to see people get enough to eat. We have never made good on our promises. I say after eight years of this administration, we have just as much unemployment as when we started. And enormous debt to boot."
Ultimately, it was the enormous war-time spending and mobilization for World War II that doubled the GNP and led the United States out of the Great Depression--not the federal work programs that are so often cited today as the solutions for the Depression’s dark days. And were it not for World War II, Morgenthau had every right to be concerned that FDR’s policies were driving the United States into an ever-deepening hole.
FDR’s Fiscal Solution to the Depression
FDR subscribed to Keynes’ theory that economic depression was due largely to a lack of consumer demand. As consumer demand decreases, Keynes said, excess inventory causes businesses to lay off employees…and so it goes, a vicious cycle where fewer consumers lead to even lower demand. And how to increase demand? Keynes’ solution was to increase government spending and cut taxes for the lower economic strata (because they would be more likely to spend the money they retain). This concept became known as fiscal policy. When people are left with more money after taxes, they could use the money to purchase more goods and services and businesses would increase production to meet demand, and they would then hire more workers.
Keynes’ Critics and Competing Monetary Policy as a Solution
Friedrich Hayek was a professor at the London School of Economics from 1931 to 1950, and criticized Keynesian policy for what he called its “fundamentally collectivist” approach that relied on centralized planning. Hayek argued that centralized planning leads to totalitarian abuses. Hayek also argued that recessions are caused primarily by micro-economic factors. What typically start as temporary government fixes become permanent and expansive government programs that stifle the private sector and civil society (think low-interest, sub-prime and no-doc mortgages made available through Fannie Mae and Freddie Mac).
Fast forward, then, to the late 1970s and early 1980s. Enter the Monetarists, led by economist Milton Friedman, who argued that the best way to create a healthy economy is to control the money supply—something that could be effectively run through the Federal Reserve System. The Federal Reserve, or “Fed”, controls the supply of money through the purchase and sales of U.S. government securities, regulating how much money Federal Reserve banks have on deposit, and setting interest rates that member federal reserve banks pay when they borrow from the Federal Reserve. In order to stimulate the economy, the money supply could be expanded, and tightened to cool it down. In other words, the "Fed" lowers interest rates when the economy is sluggish and raises rates when the threat of inflation rears its ugly head.
In fact, Friedman argued that FDR’s Keynesian policies were largely to blame for the severity of the Great Depression. In 2002 Ben Bernanke (then a Federal Reserve governor, today the Chairman of the Board of Governors) made this startling admission in a speech given in honor of Friedman’s 90th birthday: “I would like to say to Milton and Anna: Regarding the Great Depression, you’re right. We did it. We’re very sorry.”
Hopefully, a speech about how Keynesian economic policy worsened the current economic crisis will not be necessary in the years ahead. And hopefully, President Obama and his advisors will come to understand that the historical analogies of avoiding another Great Depression only take us so far. Our current crisis is very different from 1929, but the effects will likely endure for the decade to come.
Alternative solutions to our economic crisis can be found primarily in a strong dollar, a balanced budget, and most immediately in the imposition of structured bankruptcy for our financial institutions and industries that need to be reformed (read, the Big 3).
In fact, no financial or industrial institution is “too big to fail.” Until we realize that, we run the risk of a catastrophic National failure.
On the surface of things, Keynesian policy makes eminent sense, doesn’t it? Indeed, Franklin Delano Roosevelt invoked Keynes almost exclusively in devising the New Deal to combat the economic depression of the time. Creating programs such as the Civilian Conservation Corps (CCC) and the Works Progress Administration (WPA), the federal government became the “employer of last resort” Over the next decade, businesses often perceived themselves to be under assault by Roosevelt’s economic policies. Even within the administration, internal differences were epitomized by Treasury Secretary, Henry Morgenthau, who was intensely uncomfortable with FDR’s Keynesian approach. In May 1939, Morgenthau wrote in his diary:
"We have tried spending money. We are spending more than we have ever spent before and it does not work. And I have just one interest, and now if I am wrong somebody else can have my job. I want to see this country prosper. I want to see people get a job. I want to see people get enough to eat. We have never made good on our promises. I say after eight years of this administration, we have just as much unemployment as when we started. And enormous debt to boot."
Ultimately, it was the enormous war-time spending and mobilization for World War II that doubled the GNP and led the United States out of the Great Depression--not the federal work programs that are so often cited today as the solutions for the Depression’s dark days. And were it not for World War II, Morgenthau had every right to be concerned that FDR’s policies were driving the United States into an ever-deepening hole.
FDR’s Fiscal Solution to the Depression
FDR subscribed to Keynes’ theory that economic depression was due largely to a lack of consumer demand. As consumer demand decreases, Keynes said, excess inventory causes businesses to lay off employees…and so it goes, a vicious cycle where fewer consumers lead to even lower demand. And how to increase demand? Keynes’ solution was to increase government spending and cut taxes for the lower economic strata (because they would be more likely to spend the money they retain). This concept became known as fiscal policy. When people are left with more money after taxes, they could use the money to purchase more goods and services and businesses would increase production to meet demand, and they would then hire more workers.
Keynes’ Critics and Competing Monetary Policy as a Solution
Friedrich Hayek was a professor at the London School of Economics from 1931 to 1950, and criticized Keynesian policy for what he called its “fundamentally collectivist” approach that relied on centralized planning. Hayek argued that centralized planning leads to totalitarian abuses. Hayek also argued that recessions are caused primarily by micro-economic factors. What typically start as temporary government fixes become permanent and expansive government programs that stifle the private sector and civil society (think low-interest, sub-prime and no-doc mortgages made available through Fannie Mae and Freddie Mac).
Fast forward, then, to the late 1970s and early 1980s. Enter the Monetarists, led by economist Milton Friedman, who argued that the best way to create a healthy economy is to control the money supply—something that could be effectively run through the Federal Reserve System. The Federal Reserve, or “Fed”, controls the supply of money through the purchase and sales of U.S. government securities, regulating how much money Federal Reserve banks have on deposit, and setting interest rates that member federal reserve banks pay when they borrow from the Federal Reserve. In order to stimulate the economy, the money supply could be expanded, and tightened to cool it down. In other words, the "Fed" lowers interest rates when the economy is sluggish and raises rates when the threat of inflation rears its ugly head.
In fact, Friedman argued that FDR’s Keynesian policies were largely to blame for the severity of the Great Depression. In 2002 Ben Bernanke (then a Federal Reserve governor, today the Chairman of the Board of Governors) made this startling admission in a speech given in honor of Friedman’s 90th birthday: “I would like to say to Milton and Anna: Regarding the Great Depression, you’re right. We did it. We’re very sorry.”
Hopefully, a speech about how Keynesian economic policy worsened the current economic crisis will not be necessary in the years ahead. And hopefully, President Obama and his advisors will come to understand that the historical analogies of avoiding another Great Depression only take us so far. Our current crisis is very different from 1929, but the effects will likely endure for the decade to come.
Alternative solutions to our economic crisis can be found primarily in a strong dollar, a balanced budget, and most immediately in the imposition of structured bankruptcy for our financial institutions and industries that need to be reformed (read, the Big 3).
In fact, no financial or industrial institution is “too big to fail.” Until we realize that, we run the risk of a catastrophic National failure.
