Wondering why government can’t restart the sluggish economy? Well, one reason is that we are still paying the price for the greatest blunder in domestic policy since World War II. This occurred a half-century ago and helps explain today’s policy paralysis. The story is worth understanding.
Until the 1960s, Americans generally believed in low inflation and balanced budgets. President John Kennedy shared the consensus but was persuaded to change his mind. His economic advisers argued that, through deficit spending and modest increases in inflation, government could raise economic growth, lower unemployment and smooth business cycles.
None of this proved true; all of it led to grief.
Chapter 1 involved inflation. Increases weren’t modest; by 1980, they approached 14 percent annually. Business cycles weren’t smoothed; from 1969 to 1981, there were four recessions. Unemployment, on average, didn’t fall; the peak monthly rate was 10.8 percent.
Now comes Chapter 2: How the retreat from balanced budgets has weakened America’s response to today’s downturn, the worst since the Great Depression. It has limited government’s ability to “stimulate” the economy through higher spending or deeper tax cuts — or, at least, to have a legitimate debate over these proposals. The careless resort to deficits in the past has made them harder to use in the present, when the justification is stronger.
The balanced-budget tradition was never completely rigid. During wars and deep economic downturns, budgets were allowed to sink into deficit. But in normal times, balance was the standard.
Kennedy’s economists, fashioning themselves as heirs to John Maynard Keynes (1883-1946), shattered this consensus. They contended that deficits weren’t immoral and could be manipulated to boost economic performance.
Norms changed. Political leaders and average Americans noticed that continuous deficits did no great economic harm. Neither, of course, did they do much good, but their charm was “something for nothing.” Politicians could spend more and tax less.
We are now facing the consequences of all these permissive deficits. The recovery is lackluster. Economic growth creeps along at 2 percent annually or less. Unemployment has exceeded 8 percent for 41 months. But economic policy seems ineffective. Since late 2008, the Federal Reserve has kept interest rates low. And budget deficits are enormous, about $5.5 trillion since 2008.
Only one group of economists has a coherent response: Keynesians. Led by New York Times columnist Paul Krugman, they argue that the deficits haven’t been large enough. If consumers and businesses aren’t spending enough to revive the economy, government must substitute. Its support would be temporary until more jobs and profits strengthened private spending. Sounds convincing.
But it collides with the 1960s’ legacy. Running routine deficits meant that the federal debt (all past annual deficits) was already high before the crisis: 41 percent of gross domestic product in 2008. Huge deficits have raised that to about 70 percent of GDP; Krugmanlike proposals would increase debt further.
Now, imagine that the country had adhered to its balanced-budget tradition before the crisis. Some deficits would have remained, but the cumulative debt would have been much lower. There would have been more room for expansion.
The blunder of the ’60s has had a long afterlife. Economic policy is trapped between weak demand and the fears of too much debt. Yesterday’s Keynesians undercut today’s Keynesians. “In the long run, we are all dead,” Keynes said. But others are alive — and suffer from bad decisions made decades ago.
Robert J. Samuelson is a columnist for The Washington Post and writes about business and economic issues.
