One disturbing thing about studying economic history is how things that happen in the present change the past — or at least our understanding of the past. For decades, I have confidently taught my students about the rise of governments that take on responsibility for the state of the economy, but the political reaction to the Great Recession has changed the way we should think about this issue.
Governments before World War I — and even more so before World War II — did not embrace the mission of minimizing unemployment during economic downturns. There were three reasons, all of which vanished by the end of World War II.
First, there was a hard-money lobby: A substantial number of rich, socially influential and politically powerful people held investments overwhelmingly in bonds. They had little personally at stake in high capacity utilization and low unemployment, but a great deal at stake in stable prices. They wanted hard money above everything.
Second, the working classes that were hardest-hit by high unemployment generally did not have the vote. Where they did, they and their representatives had no good way to think about how they could benefit from stimulative government policies to moderate economic downturns and no way to reach the levers of power in any event.
Third, knowledge about the economy was in its adolescence. Knowledge of how different government policies could affect the overall level of spending was closely held. With the exception of the US’ free-silver movement, it was not the subject of general political and public intellectual discussion.
All three of these factors vanished between the world wars. At least, that is what I said when I lectured on economic history back in 2007. Today, we have next to no hard-money lobby, almost all investors have substantially diversified portfolios and nearly everybody suffers mightily when unemployment is high and capacity utilization and spending are low.
Economists today know a great deal more — albeit not as much as we would like — about how monetary, banking and fiscal policies affect the flow of nominal spending and their findings are the topic of a great deal of open and deep political and public intellectual discussion. And the working classes all have the vote.
Thus, I would confidently lecture only three short years ago that the days when governments could stand back and let the business cycle wreak havoc were over in the rich world. No such government today, I said, could or would tolerate any prolonged period in which the unemployment rate was kissing 10 percent and inflation was quiescent without doing something major about it.
I was wrong. That is precisely what is happening.
How did we get here? How can the US have a large political movement — the Tea Party — pushing for the hardest of hard-money policies when there is no hard-money lobby with its wealth on the line? How is it that the unemployed, and those who fear they might be the next wave of unemployed, do not register to vote? Why are politicians not terrified of their displeasure?
Economic questions abound, too. Why are the principles of nominal income determination, which I thought had been largely settled since 1829, now being questioned? Why is the idea, common to John Maynard Keynes, Milton Friedman, Knut Wicksell, Irving Fisher and Walter Bagehot alike, that governments must intervene strategically in financial markets to stabilize economy-wide spending now a contested one?