Brad Delong is an extremely smart, trenchant and witty economist. He has just published a piece comparing the Great Depression of the 1930s with the ongoing Great Recession of today and drawing lessons from the experiences of both episodes. It is typically erudite and deals with complex issues in a clear and concise way. However, being trenchant and concise has its dangers, not least of which is missing things out. This can happen, and the costs will often be small relative the benefits of maintaining focus on the key issues (and not boring readers). What is surprising and worrying in this case is that Brad Delong – a renowned economic historian and one very open to Keynesian views – has missed out the thirty important years of economic history and very much downplays Keynesian economics in that period and also since.
In a nutshell – you really should read the whole article – Delong argues the following:
- The Great Depression happened because policy makers didn’t understand the problem and thus failed to do what was necessary (or made things worse): they lent freely to banks in bad shape, but the insisted on sound finance and balanced budgets.
- Milton Friedmann and Anna Schwarz said in the 1960s that the problem had been that the Fed focused on the interest rate (the price of money), rather than the quantity of money. The Great Depression would have been avoided had the Fed prevented the money supply contracting.
- Economists in general and Ben Bernanke in particular accepted this view and so the Fed kept up the money supply when the Great Recession hit.
- This was partially successful (performance was better than the Great Depression), but not nearly enough. This reason is that pumping money into the system doesn’t help if people do not crave liquidity so much as safety (lower debt and fewer risky assets).
- What actually got countries out of the Great Depression was some combination of devaluation (getting off the Gold Standard), creating expectations of higher inflation and deficit spending.
There is nothing actually wrong with this line of reasoning, but:
a) what about the “trentes glorieuses” from 1945-1975?
Brad Delong starts the post-war story with Friedman/Schwarz in the 1960s, whose doctrines were not accepted until the late 1970s, and then radicalised by the likes of Lucas to the extent that the problem of cyclical demand management was believed to have been solved: all you have to do is ensure steady growth of the money supply. But he overlooks the preceding period which was characterised by steady and strong growth and a lack of (financial) crises in the advanced capitalist countries. It was also characterised by strict regulation of the financial sector, an expansion of the welfare state (and thus also of automatic fiscal stabilisers) and a belief in the use of both monetary and fiscal policy for counter-cyclical purposes. Which brings me to:
b) what about Keynesian economics?
Brad only mentions Keynes in the context of the debate about the Great Depression, not subsequently. But the predominance of Keynesian theories at least coincided temporally with (and I would argue was a causal factor behind) thirty years of crisis-free growth. Post-war Keynesianism was replaced by the doctrines of, yes, Milton Friedman and Robert Lucas. While Friedman, at least, believed in the counter cyclical use of monetary policy, increasingly his followers, and notably Lucas, focused on market-promoting supply side reforms as the Holy Grail of economic policy. Three important components and consequences of this approach were: Reduction in the size of (and the increased marketisation of) welfare-spending and government “meddling” in the economy, which reduced the size of the automatic stabilisers. Financial market liberalisation: supposedly efficiency-enhancing, this made the economic system far more fragile for reasons that had been long understood – not just by Minsky and Koo, whom Brad approvingly cites – but also people like Kalecki and Keynes himself. And exchange-rate and capital account liberalisation which presaged a series of boom-bust episodes in emerging markets.
Missing all this out, it seems to me, is taking concision and parsimony rather too far. It is certainly true that much of the economic profession bought into monetarist and market-radical ideas. But the fact is that these had driven out theories and policy convictions that continued to be held by a minority of Keynesians and that were – perhaps not in all respects, but in many – much superior. It is not that the Friedmanite counter-revolution and what followed did not contain any useful ideas (expectations; problems of using fiscal policy effectively). But much that was useful was buried.
In short, we didn’t actually need to go through the Great Recession to see that Friedman and Schwarz were wrong.
Coincidentally, today I saw a nice example of the fact that – let us be generous – scientific progress is not linear. Economists at the European Commission – a champion of pre-crisis financial liberalisation in Europe – are now experimenting with enriching their DSGE model with the path-breaking idea that investors cannot simply borrow without limit at the prevailing rate of interest but normally require collateral. The availability of credit depends on the (expected market) value of that collateral. This creates the potential for self-reinforcing booms and subsequent slumps. This path-breaking idea was set out (at the latest) by Michal Kalecki in 1937. Needless to say he is not included in the list of references.