The Rise and Fall of the Keynesian Consensus
The elimination of mass unemployment during the Second World War had a
profound influence on the spread and influence of Keynesian ideas concerning
the responsibility of government for maintaining full employment. In the
UK, William Beveridge’s Full Employment in a Free Society was published
in 1944 and in the same year the government also committed itself to the
maintenance of a ‘high and stable level of employment’ in a White Paper on
Employment Policy. In the USA, the Employment Act of 1946 dedicated the
Federal Government to the pursuit of ‘maximum employment, production
and purchasing power’. These commitments in both the UK and the USA
were of great symbolic significance although they lacked specific discussion
of how such objectives were to be attained. In the case of the UK, Keynes
thought that the Beveridge target of an average level of unemployment of 3
per cent was far too optimistic although there was ‘no harm in trying’ (see
Hutchison, 1977). Nevertheless the post-war prosperity enjoyed in the advanced
economies was assumed to be in large part the direct result of Keynesian
stabilization policies. In the words of Tobin who, until his death in 2002, was
the USA’s most prominent Keynesian economist:
A strong case has been made for the success of Keynesian policies. Virtually all
advanced democratic capitalist societies adopted, in varying degrees, Keynesian
strategies of demand management after World War Two. The period, certainly
between 1950 and 1973, was one of unparalleled prosperity, growth, expansion of
world trade, and stability. During this ‘Golden Age’ inflation and unemployment
were low, the business cycle was tamed. (Tobin, 1987)
In a similar vein, Stewart (1986) has also argued that:
the common sense conclusion is that Britain and other Western countries had full
employment for a quarter of a century after the war because their governments
were committed to full employment, and knew how to secure it; and they knew
how to secure it because Keynes had told them how.
It is also the case that before the 1980s it was conventional wisdom that real
output had been more stable in the USA ‘under conscious policies of built-in
and discretionary stabilisation adopted since 1946 and particularly since 1961’
compared to the period before the Second World War (Tobin, 1980a). This
was one of the most widely held empirical generalizations about the US
economy (Burns, 1959; Bailey, 1978). However, Christina Romer, in a series
of very influential papers, challenged the conventional macroeconomic wisdom
that for the US economy, the period after 1945 had been more stable
than the pre-Great Depression period (see C. Romer, 1986a, 1986b, 1986c,
1989, 1994). Romer’s thesis, expressed in her 1986 papers, is that the business
cycle in the pre-Great Depression period was only slightly more severe
than the instability experienced after 1945. In a close examination of data
relating to unemployment, industrial production and GNP, Romer discovered
that the methods used in the construction of the historical data led to systematic
biases in the results. These biases exaggerated the pre-Great Depression
data relating to cyclical movements. Thus the conventional assessment of the
historical record of instability that paints a picture of substantial reductions in
volatility is in reality a popular, but mistaken, view, based on a ‘figment of
the data’. By creating post-1945 data that are consistent with pre-1945 data
Romer was able to show that both booms and recessions are more severe
after 1945 than is shown in the conventional data. Romer also constructed
new GNP data for the pre-1916 era and found that cyclical fluctuations are
much less severe in the new data series than the original Kuznets estimates.
Thus Romer concludes that there is in fact little evidence that the pre-1929
US economy was much more volatile than the post-1945 economy. Of course
this same analysis also implies that the Great Depression was an event of
‘unprecedented magnitude’ well out of line with what went before as well as
after. As Romer (1986b) writes, ‘rather than being the worst of many, very
severe pre-war depressions, the Great Depression stands out as the unprecedented
collapse of a relatively stable pre-war economy’. In other words, the
Understanding modern macroeconomics 17
Great Depression was not the norm for capitalism but a truly unique event.
Although initially critical of Romer’s findings, DeLong now accepts that
Romer’s critique is correct (DeLong and Summers, 1986; DeLong, 2001; see
also the DeLong and Romer interviews in Snowdon, 2002a).
In a recent paper Romer (1999) has surveyed the facts about short-run
fluctuations relating to US data since the late nineteenth century. There she
concludes that although the volatility of real macroeconomic indicators and
average severity of recessions has declined only slightly between the pre-
1916 and post-1945 periods, there is strong evidence that recessions have
become less frequent and more uniform. The impact of stabilization policies
has been to prolong post-1945 expansions and prevent severe economic downturns.
However, there are also examples of policy-induced booms (for example
1962–9 and 1970–73) and recessions (for example 1980–82) since 1945 and
this is what ‘explains why the economy has remained volatile in the post-war
era’.
Even if we accept the conventional view that the post-war economy has
been much more stable than the pre-1914 era, not everyone would agree that
there was a Keynesian revolution in economic policy (the opposing views are
well represented in Stein, 1969; Robinson, 1972; Tomlinson, 1984; Booth,
1985; Salant, 1988; Laidler, 1999). Some authors have also questioned whether
it was the traditional Keynesian emphasis on fiscal policy that made the
difference to economic performance in the period after 1945 (Matthews,
1968). What is not in doubt is that from the end of the Second World War
until 1973 the industrial market economies enjoyed a ‘Golden Age’ of unparalleled
prosperity. Maddison (1979, 1980) has identified several special
characteristics which contributed to this period of exceptional economic performance:
1. increased liberalization of international trade and transactions;
2. favourable circumstances and policies which contributed to producing
low inflation in conditions of very buoyant aggregate demand;
3. active government promotion of buoyant domestic demand;
4. a backlog of growth possibilities following the end of the Second World
War.
As Table 1.2 indicates, growth of per capita GDP in Western Europe, which
averaged 4.08 per cent during the period 1950–73, was unprecedented. Although
Crafts and Toniolo (1996) view the ‘Golden Age’ as a ‘distinctly
European phenomenon’, it should be noted that the growth miracle also
extended to the centrally planned economies: Latin America, Asia and Africa.
During this same period growth of per capita GDP in Japan was nothing less
than exceptional, averaging 8.05 per cent. Table 1.3 presents data on growth
rates of GDP for the G7 for the same five sub-periods over the period 1820–
1998. The table further demonstrates the historically high growth performance
achieved during the period 1950–73, especially in France, Germany, Italy and
Japan (see Chapter 11).
Whatever the causes, this ‘Golden Age’ came to an end after 1973 and the
economic problems of the 1970s brought the Keynesian bandwagon to an
abrupt (but temporary) halt. The acceleration of inflation, rising unemployment
and a slowdown in economic growth during the
1970s were attributed, by Keynesian critics, to the misguided expansionary
policies carried out in the name of Keynes. Taking the 1960–2002 period as a
whole, on average in the ‘Golden Age’ both unemployment and inflation
were low. In the period 1983–93, inflation came down but unemployment
remained stubbornly high in many countries, especially in Western Europe
where high unemployment has been attributed by some economists to hysteresis
effects and/or various labour market rigidities (see Chapter 7). In the
most recent period, 1994–2002, inflation was low but unemployment remained
high in Western Europe while it declined in the USA. But only in the
period 1973–83 do we see the simultaneous combination of high unemployment
and high inflation, i.e. stagflation. To the critics of Keynesianism
stagflation was an inevitable legacy of the ‘Golden Age’ of demand management
(Friedman, 1975; Bruno and Sachs, 1985; DeLong, 1997; see also
Cairncross and Cairncross, 1992, for a discussion of the legacy of the 1960s).
The elimination of mass unemployment during the Second World War had a
profound influence on the spread and influence of Keynesian ideas concerning
the responsibility of government for maintaining full employment. In the
UK, William Beveridge’s Full Employment in a Free Society was published
in 1944 and in the same year the government also committed itself to the
maintenance of a ‘high and stable level of employment’ in a White Paper on
Employment Policy. In the USA, the Employment Act of 1946 dedicated the
Federal Government to the pursuit of ‘maximum employment, production
and purchasing power’. These commitments in both the UK and the USA
were of great symbolic significance although they lacked specific discussion
of how such objectives were to be attained. In the case of the UK, Keynes
thought that the Beveridge target of an average level of unemployment of 3
per cent was far too optimistic although there was ‘no harm in trying’ (see
Hutchison, 1977). Nevertheless the post-war prosperity enjoyed in the advanced
economies was assumed to be in large part the direct result of Keynesian
stabilization policies. In the words of Tobin who, until his death in 2002, was
the USA’s most prominent Keynesian economist:
A strong case has been made for the success of Keynesian policies. Virtually all
advanced democratic capitalist societies adopted, in varying degrees, Keynesian
strategies of demand management after World War Two. The period, certainly
between 1950 and 1973, was one of unparalleled prosperity, growth, expansion of
world trade, and stability. During this ‘Golden Age’ inflation and unemployment
were low, the business cycle was tamed. (Tobin, 1987)
In a similar vein, Stewart (1986) has also argued that:
the common sense conclusion is that Britain and other Western countries had full
employment for a quarter of a century after the war because their governments
were committed to full employment, and knew how to secure it; and they knew
how to secure it because Keynes had told them how.
It is also the case that before the 1980s it was conventional wisdom that real
output had been more stable in the USA ‘under conscious policies of built-in
and discretionary stabilisation adopted since 1946 and particularly since 1961’
compared to the period before the Second World War (Tobin, 1980a). This
was one of the most widely held empirical generalizations about the US
economy (Burns, 1959; Bailey, 1978). However, Christina Romer, in a series
of very influential papers, challenged the conventional macroeconomic wisdom
that for the US economy, the period after 1945 had been more stable
than the pre-Great Depression period (see C. Romer, 1986a, 1986b, 1986c,
1989, 1994). Romer’s thesis, expressed in her 1986 papers, is that the business
cycle in the pre-Great Depression period was only slightly more severe
than the instability experienced after 1945. In a close examination of data
relating to unemployment, industrial production and GNP, Romer discovered
that the methods used in the construction of the historical data led to systematic
biases in the results. These biases exaggerated the pre-Great Depression
data relating to cyclical movements. Thus the conventional assessment of the
historical record of instability that paints a picture of substantial reductions in
volatility is in reality a popular, but mistaken, view, based on a ‘figment of
the data’. By creating post-1945 data that are consistent with pre-1945 data
Romer was able to show that both booms and recessions are more severe
after 1945 than is shown in the conventional data. Romer also constructed
new GNP data for the pre-1916 era and found that cyclical fluctuations are
much less severe in the new data series than the original Kuznets estimates.
Thus Romer concludes that there is in fact little evidence that the pre-1929
US economy was much more volatile than the post-1945 economy. Of course
this same analysis also implies that the Great Depression was an event of
‘unprecedented magnitude’ well out of line with what went before as well as
after. As Romer (1986b) writes, ‘rather than being the worst of many, very
severe pre-war depressions, the Great Depression stands out as the unprecedented
collapse of a relatively stable pre-war economy’. In other words, the
Understanding modern macroeconomics 17
Great Depression was not the norm for capitalism but a truly unique event.
Although initially critical of Romer’s findings, DeLong now accepts that
Romer’s critique is correct (DeLong and Summers, 1986; DeLong, 2001; see
also the DeLong and Romer interviews in Snowdon, 2002a).
In a recent paper Romer (1999) has surveyed the facts about short-run
fluctuations relating to US data since the late nineteenth century. There she
concludes that although the volatility of real macroeconomic indicators and
average severity of recessions has declined only slightly between the pre-
1916 and post-1945 periods, there is strong evidence that recessions have
become less frequent and more uniform. The impact of stabilization policies
has been to prolong post-1945 expansions and prevent severe economic downturns.
However, there are also examples of policy-induced booms (for example
1962–9 and 1970–73) and recessions (for example 1980–82) since 1945 and
this is what ‘explains why the economy has remained volatile in the post-war
era’.
Even if we accept the conventional view that the post-war economy has
been much more stable than the pre-1914 era, not everyone would agree that
there was a Keynesian revolution in economic policy (the opposing views are
well represented in Stein, 1969; Robinson, 1972; Tomlinson, 1984; Booth,
1985; Salant, 1988; Laidler, 1999). Some authors have also questioned whether
it was the traditional Keynesian emphasis on fiscal policy that made the
difference to economic performance in the period after 1945 (Matthews,
1968). What is not in doubt is that from the end of the Second World War
until 1973 the industrial market economies enjoyed a ‘Golden Age’ of unparalleled
prosperity. Maddison (1979, 1980) has identified several special
characteristics which contributed to this period of exceptional economic performance:
1. increased liberalization of international trade and transactions;
2. favourable circumstances and policies which contributed to producing
low inflation in conditions of very buoyant aggregate demand;
3. active government promotion of buoyant domestic demand;
4. a backlog of growth possibilities following the end of the Second World
War.
As Table 1.2 indicates, growth of per capita GDP in Western Europe, which
averaged 4.08 per cent during the period 1950–73, was unprecedented. Although
Crafts and Toniolo (1996) view the ‘Golden Age’ as a ‘distinctly
European phenomenon’, it should be noted that the growth miracle also
extended to the centrally planned economies: Latin America, Asia and Africa.
During this same period growth of per capita GDP in Japan was nothing less
than exceptional, averaging 8.05 per cent. Table 1.3 presents data on growth
rates of GDP for the G7 for the same five sub-periods over the period 1820–
1998. The table further demonstrates the historically high growth performance
achieved during the period 1950–73, especially in France, Germany, Italy and
Japan (see Chapter 11).
Whatever the causes, this ‘Golden Age’ came to an end after 1973 and the
economic problems of the 1970s brought the Keynesian bandwagon to an
abrupt (but temporary) halt. The acceleration of inflation, rising unemployment
and a slowdown in economic growth during the
1970s were attributed, by Keynesian critics, to the misguided expansionary
policies carried out in the name of Keynes. Taking the 1960–2002 period as a
whole, on average in the ‘Golden Age’ both unemployment and inflation
were low. In the period 1983–93, inflation came down but unemployment
remained stubbornly high in many countries, especially in Western Europe
where high unemployment has been attributed by some economists to hysteresis
effects and/or various labour market rigidities (see Chapter 7). In the
most recent period, 1994–2002, inflation was low but unemployment remained
high in Western Europe while it declined in the USA. But only in the
period 1973–83 do we see the simultaneous combination of high unemployment
and high inflation, i.e. stagflation. To the critics of Keynesianism
stagflation was an inevitable legacy of the ‘Golden Age’ of demand management
(Friedman, 1975; Bruno and Sachs, 1985; DeLong, 1997; see also
Cairncross and Cairncross, 1992, for a discussion of the legacy of the 1960s).
No comments:
Post a Comment