When central bankers from around the world met in Aspen, Colorado, last week, one question kept dogging them: was monetary policy played out? If so, what should be done to jolt their economies out of their sleepy recovery from the Great Recession?
Was this history repeating? Or is a global economic lethargy unique to our time?
A little history can shed some light on the question. In 1935, in the depths of what seemed to be an endless Great Depression, a U. S. Representative named T. Alan Goldsboro was at a hearing on what the Federal Reserve could do to help the American economy. When then Fed Chairman Marriner Eccles allowed as that the banking system had done everything that could be done, Rep. Goldsboro described the bank’s situation as being, “… like pushing on a string.”
What his simile means for economists is that monetary policy is better at restraining an overheated economy than it is at trying to wake up a drowsy one. Former Federal Reserve Chairman Alan Greenspan once described his job as “taking away the punch bowl just as the party is warming up.”
But refilling the punch bowl won’t necessarily revive a moribund party. An “easy money” policy doesn’t guarantee that businesses will increase the level of investment to what is needed for vigorous economic growth. Former President George W. Bush found this out when he lowered the tax on repatriated overseas corporate cash. The corporations brought back the money to the U.S., but then dissipated it on stock dividends while investments remained unchanged.
The central bank’s policies can make it less expensive to borrow but it cannot make firms borrow for investment, or consumers spend.
In 1936, economist John Maynard Keynes, a British economist and noted monetary expert, published his “General Theory of Employment, Interest, and Money” in which he described the use of government spending to stimulate economic growth. World War II intervened, though, before it could be translated into policy.
Government spending on military personnel and equipment boosted our economy back to full capacity and beyond. And we spent a lot of money. For years to come, the bulk of U.S. public debt was traceable to the huge deficits run up to underwrite the cost of the war.
The resultant boost to the economy had been expected, and the inflation that usually accompanies spending of that magnitude was held in check by price controls, rationing, and public purchases of war bonds. None of these methods would have been successful, however, without the patriotic fervor that insured cooperation.
The military spending didn’t just jump-start the economy, though; once it got rolling again it didn’t stop when the war, and the spending, were over. The experts and almost everybody else, including Congress, had expected that the wartime boom would end in a bust, just as it did after World War I. But it didn’t happen.
What happened instead was a prolonged economic growth, only briefly interrupted by a few, relatively painless business-cycle recessions. This gave tremendous credibility to Keynes’ theory. By the mid-1960s economic policy makers could, and did, declare, “We’re all Keynesians now.”
Unfortunately, Keynesian or not, prolonged deficit spending produced the common-sense result: inflation. And by the late 1970s it was out of control. This was combined with economic stagnation to produce something new in the American economy: “stagflation.” Only Federal Reserve intervention to push interest rates to near 20 percent eventually coaxed the economy to cool down.
With the bloom off the Keynesian rose, and the federal deficits pressing the limits of public and market acceptance, there was a renewed interest in monetary theory and the work of Milton Friedman. By the 1990s, we could say, “we are all monetarists now” and the Chairman of the Federal Reserve was worshipped as the rock on which our prosperity was built.
It turned out, though, that the fundamental shortcoming of monetary policy hadn’t gone away. It was still like “pushing on a string.” When our economy lapsed into a sleepwalking-like recovery from the Great Recession, The Fed did all it could — and that was a lot — to restore confidence and encourage investment but by itself it hasn’t been able to reawaken it.
It is going to take a resurgence of confidence and some creative financing of government investment to move our economy into a higher gear. Using tax incentives to motivate corporations to use their repatriated cash to underwrite stock in a public-private infrastructure repair corporation is one example. And removing some structural barriers like our labyrinthian tax code would also help. In the longer run, though, it appears that only a coordinated action of both monetary and fiscal policy working together is powerful enough to give us the robust economy we need.
James McCusker is a Bothell economist, educator and consultant.