Bad Conventional Wisdom, Then and Now

“By 1960, progressive income taxation on the one hand

and income support measures for the poor on the other

hand were accepted by all but the most unreconstructed

conservatives.”

Herbert Stein, Presidential Economics. Third Revised Edition 1993

(Chairman, Council of Economic Advisors under Nixon)

 Since 1980 a whole lot of deconstruction has been going on, particularly in the Republican Party. Mr. Stein, who was chairman of the Council of Economic Advisors (CEA) in the Nixon Administration and a founder of the American Enterprise Institute, considered himself a Rockefeller Republican. This brand of fiscally moderate, internationalist Republicanism is all but extinct. There may be a member or two of the species still alive in Maine but it’s not clear a breeding pair has survived.

Since 1980 a strident quasi-religious brand of conservatism has fully captured the Republican Party. They’ve rediscovered all the bad advice that Andrew Mellon gave Hoover and made it part of their dogma. The empirically based conservatism of Milton Friedman is no longer part of the received wisdom.

They claim that we are heading down the Grecian path to fiscal ruin while extolling the austerity policies that guarantee decline. There is not a shard of evidence demonstrating that austerity is an effective way out of the current economic problems facing the Greeks or the rest of west. Iceland has the one crisis  economy that is actually generating some heat and their policy is determinedly anti-austerity.

It’s been over four years (Dec ember 2007) since the recession officially began and three years (June 2009) since the recovery officially started. It is the first major financial crisis since the Great Depression and involves all of the major western economies. Even the German banking system is fragile.

The US is recovering very slowly and Europe is stagnant. At the current pace of recovery it will be years before we regain a semblance of a fully employed economy. How did we get here?

Our sustained prosperity of the 1990s was framed by monetary and fiscal policies antithetical to the current conservative cant. Taxes were raised early in the recovery process and monetary policy accommodated the real expansion. The result was an unequaled experience with 108 months of uninterrupted expansion, falling unemployment rates, stable prices and falling federal deficits.

Clearly the monetary and fiscal policies of the period were consistent with uninterrupted prosperity. At the very least policy didn’t get in the way. At the same time structural changes were occurring. Manufacturing was continuing its relative decline, internet industries were enjoying birth and growth, and the financial sector was undergoing growth and deregulation.

Until the current serious financial crises, post WWII history of business cycles indicated that monetary and fiscal policies in the western economies has been consistent with shorter, less extreme business cycles than pre-WWII experience. This is a modest claim, but indicates monetary and fiscal policy as practiced in the US has been more beneficial than its conservative critics claim.

These critics have now left the reservation and are preaching a version of fiscal and monetary austerity that is theoretically and empirically bankrupt given the current circumstances. This bizarre advice has been followed by the Euro Zone countries and the results are apparent. The southern tier of countries has gone from recession to depression. The Irish and British economies are returning to recession and their debt loads are increasing. The German economy is heading towards a stall speed. It’s all pain and no gain. At some time common sense will triumph ideology. In the meantime unemployment will increase and debt will increase. This state of affairs can only be characterized as economic sadism.