That 70s Show

I reached adulthood in the 1970s.  It was an era of pessimism, economic malaise and confusion. And don’t get me started about the hideous fashion. The overall zeitgeist of that era was hard to describe to younger folks, until quite recently. (“Too many college grads without real jobs” resonates today in a way that it did not, for example, during the tech boom of the late 1990s.)

Back then, the principal economic model was Keynesian demand management, which so dominated policy thought that in 1971 President Richard Nixon proclaimed, “We are all Keynesians now.”

By the end of the 1970s, the grim result of a decade of Keynesian stimulus was stagflation — an ugly combination of chronic inflation with persistent unemployment.  Under prevailing economic theory, this was an unanticipated result, so much so that our economic problems seemed not just insoluble, but beyond understanding.  Economist Robert Heilbroner declared in 1981 that, “Nobody really understands what causes inflation.”

In short, the economy sucked and nobody knew how to fix it.  (Sound familiar?)

When Ronald Reagan took office in 1981, he brought a different perspective.  He believed tax rates should be lower, regulations less onerous, and that the proper inflation rate was zero, or somewhere close.  At that time, James Tobin of Yale, the rough equivalent of Paul Krugman today, denounced Reagan’s plan.  Instead of lowering taxes and wringing out inflation as Reagan proposed, Tobin thought tax rates should be raised and monetary policy loosened.

Reagan got his way.  Inflation declined sharply and the nation entered a brief but brutal recession, after which economic growth exploded.  (A huge share of the credit for lower inflation must go to Paul Volcker, a Democrat and head of the New York Fed, who Jimmy Carter reluctantly appointed as Chair of the Federal Reserve in 1979.)

Within four years of Reagan taking office, a global revolution was under way.  Governments across the ideological spectrum, from the coalition of conservative Democrats and Republicans tin the U. S. to Mitterand’s Socialists in France, put in place policies of lower taxes and tight money.

This was was not a question of ideology or intellectual persuasion, but of practical politics.  In a democracy, results usually trump theory.  Even for self-identified socialists, higher economic growth leading to higher tax revenues was an irresistible benefit, since it produced more money to spend on favored policies and constituencies.

I was trained as an historian, not an economist, so I didn’t have a dog in this economic policy fight.  As a financial guy, my concerns were entirely practical — I wanted the economy to get well and stocks to go up.  Observing the predictions of the Keynesians and the results of Reagan’s supply-side policies, I came to the simple conclusion that Keynesian economics was dumb.

My views have evolved over the last thirty years, but not reversed.  These days, I have fundamental problems with the more passionate advocates of efficient-markets theory, whose principles were clearly implicated in many of the financial-markets practices that proved so disastrous during the 2008-09 crash.  I have also developed a deep affection for Keynes’ insights into the irrational aspects of financial markets.

I remain entirely unpersuaded by fundamentalist Keynesians like Paul Krugman, who truly believe their complex models of the economy, based on Keynesian principles, can offer reliable predictions and sensible prescriptions about economic policy.  For me, that issue was settled back in the early 1980s, in the laboratory of the real world.

I am left without a satisfying economic model-of-everything.  In this I suspect I’m not alone.


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