The View From 1776
Wednesday, November 22, 2006
Democrats, the Fed, and Milton Friedman
Liberal Democrats are economic ignoramuses and they hope that the voters are too.
Neither the Democratic Party left wing, nor the Fed has learned the fundamental truth documented by the late Milton Friedman and Anna Schwartz in A Monetary History of the United States, 1867-1960.
Mr. Friedman, who died November 16, 2006, effectively eviscerated Keynesian economics, which was the academic foundation of New Deal socialistic statism and remained the economic orthodoxy of the Democratic Party after World War II.
One of Professor Friedman’s messages is that, when the government attempts to regulate the economy it almost always does more harm than good. Another is that the economy will grow faster and more steadily when the Fed acts to keep the money supply in a stable relationship to GDP. This promotes price stability, i.e., the absence of inflation.
The real economy grows and more jobs are created, not as a consequence of management by government planners, but because private businesses make long-term investments to produce more goods and services. As we saw in the 1930s Depression, businesses don’t make long-term investments when taxes are being raised, inflation is rampant, and they are continually harassed by harmful rounds of government regulations.
Nonetheless, within the last few days the press has been full of reports that the liberal-progressive-socialists in the Democratic Party intend to impose a new, state-planning straitjacket for the economy to narrow the gap between top and bottom income groups.
To do as they propose, Democrats must be willfully ignorant of the economic surges from tax cuts by presidents Kennedy, Reagan, and George W. Bush. They must also deny the disintegration of the economy and of American society produced by President Lyndon Johnson’ Great Society, the most extreme degree of socialistic planning yet imposed upon us.
The announced aims of liberal Democratic committee chairmen amounts to grave-digging to exhume the old Keyesian hypothesis that private business can never raise production enough to create full employment at acceptable wages, that only government welfare-state spending can do that.
English economist John Maynard Keynes and his Harvard economics department acolyte Alvin Hansen were primary sources of these now discredited socialistic policies that exacerbated an ordinary recession into eight years of the Great Depression under President Franklin Roosevelt, a period when, at its lowest, unemployment never averaged less than three times today’s level under President George W. Bush.
Twenty years later, confident that they finally had deciphered the gnostic content of history, Keynesian liberal economists declared that the new era of permanent prosperity was at hand. Within months their hubris, and the economy, collapsed. We were mired deeply in the worst economic conditions since the Depression: the stagflation of the 1970s, with its large-scale unemployment, bankrupt manufacturing businesses in what became the Midwestern “rust bowl,” and the worst inflation in our history. Men were forced to “moonlight” with two or three jobs and mothers were forced into the full-time workforce, just to pay the rent and grocery bills.
Never forget that our two worst economic and social periods ? the Depression and the 1970s stagflation ? were caused by liberals’ social engineering.
Following the Friedman prescription, President Reagan after 1980 revitalized our moribund economy by trying to get government off people’s backs. He cut taxes, curbed unions’ self-centered power to paralyze industrial production, reduced regulation, and took the political heat to stop inflation.
President Reagan stood behind the Fed’s new Chairman Paul Volcker, who understood Professor Friedman’s demonstration that inflation is no more than too much money chasing too few goods and services, that the way to curb inflation is to control the money supply.
In a PBS interview in more recent years, Mr. Volcker described it this way:
Well, the Federal Reserve had been attempting to deal with the inflation for some time, but I think in the 1970s, in past hindsight, anyway, [it] got behind the curve. It’s always hard to raise interest rates.
By the time I became chairman and there was more of a feeling of urgency, there was a willingness to accept more forceful measures to try to deal with the inflation. And we adopted an approach of doing it perhaps more directly, by saying, “We’ll take the emphasis off of interest rates and put the emphasis on the growth in the money supply, which is at the root cause of inflation” - too much money chasing too few goods ?- “so we’ll attack the too-much-money part of the equation and we will stop the money supply from increasing as rapidly as it was.”
And that led to a squeeze on the money markets and a squeeze on interest rates, and interest rates went up a lot. But we didn’t do it by saying, “We think the appropriate level of interest rates is X.” We said, “We think the appropriate level of the money supply or the appropriate rate of the money supply is X, and we’ll take whatever consequences that means for the interest rate because that will enable us to get inflation under control, and at that point interest rates will come down,” which, of course, eventually is what happened.
Since then the Fed has reverted to the old, completely discredited Keynesian belief that government planners can fine-tune the economy in order to attain full employment, price stability, steady GDP growth, all while expanding the money supply essentially without limit to finance ever-growing welfare-state expenditures and Congress’s massive pork-barreling.
The Fed officially acknowledges that it has abandoned Chairman Volcker’s policy of controlling the money supply in order to reduce and to forestall inflation. A 1997 policy memorandum titled Understanding Open Market Operations, published by the New York Federal Reserve Bank, states the following:
As the nation?s central bank, the Federal Reserve System is responsible for formulating and implementing monetary policy. The formulation of monetary policy involves developing a plan aimed at pursuing the goals of stable prices, full employment and, more generally, a stable financial environment for the economy. In implementing that plan, the Federal Reserve uses the tools of monetary policy to induce changes in interest rates, and the amount of money and credit in the economy. Through these financial variables, monetary policy actions influence, albeit with considerable time lags, the levels of spending, output, employment and prices.
The formulation of monetary policy has undergone significant shifts over the years. In the early 1980s, for example, the Federal Reserve placed special emphasis on objectives for the monetary aggregates as policy guides for indicating the state of the economy and for stabilizing the price level. Since that time, however, ongoing and far-reaching changes in the financial system have reduced the usefulness of the monetary aggregates as policy guides. As a consequence, monetary policy plans must be based on a much broader array of indicators.
Translation: instead of focusing on maintaining sound money by controlling the money supply, the Fed’s liberal-economics brain-trusters can’t resist presuming to control the entire economy.
This, at the same time that Democrats aim to re-impose Keynesian socialism via raising taxes, fixing wages, and grossing up welfare spending by nationalizing health care under socialized medicine.
Look for inflation to surge while business tanks.