A History of Macroeconomic Policy in the United States

John H. Wood

• Publisher: Routledge
• Year: 2009
• ISBN:
  9781135970147
• Edition: 1
• Topic: Negocios y empresa
• Subtopic: Negocios en general

This book examines the controlling influences that drive macroeconomic policies in the United States. It addresses the history of the interests, ideas, and practices of monetary and fiscal policies in the United States.

1 Introduction

There is a naïve view among economists that ‘we need to change this or that policy in order to improve economic welfare’. [T]his is impossible. The current values of policies reflect a delicate political equilibrium that balances all of society’s conflicting interests. The current negative views of economists on the policy have already been embodied in its equilibrium. The policy is endogenous and is outside the control of any group, including the politicians. They are merely the agents balancing all of the conflicting interests….

(Magee et al. 1989: xvi)

This book attempts a partial answer to the complex question: What determines monetary and fiscal policies? The answer prevalent among economists is clear and simple: economic theory. ‘Academic thinking about monetary economics—as well as macroeconomics more generally—has altered drastically since 1971–73 and so has the practice of monetary policy’, a prominent economist wrote in 2002. ‘The former has passed through the rational expectations and real-business-cycle revolutions into today’s “new neoclassical synthesis,” leading the latter “into an era of low inflation that emphasizes the concepts of central bank independence, transparency, and accountability”’ (McCallum 2002). The fluctuating inflations since World War II, a team of leading economists wrote, resulted from the applications of ‘a crude but fundamentally sensible model of how the economy worked in the 1950s to more formal but faulty models in the 1960s and 1970s to a model that was both sensible and sophisticated in the 1980s and 1990s’ (Romer and Romer 2002). Economists were just as confident of their influence four decades ago. A former chairman of the president’s Council of Economic Advisors and advocate of Keynesian interventions, wrote:

Economics has come of age in the 1960s. Two Presidents have recognized and drawn on modern economics as a source of national strength and Presidential power. Their willingness to use, for the first time, the full range of modern economic tools underlies the unbroken U.S. expansion since early 1961. [W]e have at last unleashed fiscal and monetary policy for the aggressive pursuit of those objectives.

(Heller 1966: 1–2)

‘By about 1980’, however, after another revolution in economic theory, another Keynesian economist observed that ‘it was hard to find an American academic macroeconomist under the age of 40 who professed to be a Keynesian’ (Blinder 1988). The president elected that year seemed to share the next new policy view of economists when he said: ‘Government is the problem’ (Reagan, Inaugural Address: 20 January 1981).

Changing policies are often thought to be examples of the much quoted conclusion to J.M. Keynes’s The General Theory of Employment, Interest and Money (1936: 383–4). After asking whether the application of his theory was more than ‘a visionary hope’, he answered that

the ideas of economists and political philosophers … are more powerful than is commonly understood. Indeed the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist. [S]oon or late, it is ideas, not vested interests, which are dangerous for good or evil.

These claims rest on weak foundations. Interests are more stubborn than Keynes assumed. The vanity of his hopes, and of theorists in general, is the thesis of this book. The interests—or incentives, to which we might expect economists to ascribe more influence—that govern the world have persevered. This alternative explanation of policy is supported by the record of actions of the monetary and fiscal authorities which form the substance of the pages that follow. Existing policies may not be ‘delicate equilibria’ as suggested in the opening quotation, but they are certainly endogenous and not easily manipulated by economists or politicians.

The case can be made more generally, but it is limited in this book to the United States, where it is shown that the direction of influence between economic theory and practice is primarily from the latter to the former. Notwithstanding their claims for innovation, economists have rationalized more than influenced policy. Ideas not supporting interests have been ignored in practice.

The lights of theory playing on public policies have oscillated—for example, from Classical to Keynesian to New Classical and New Keynesian—but the policies themselves have been more persistent than is generally recognized. Policymakers and policies have been more conservative than they have been given credit (or blamed) for. My purpose is neither to criticize nor defend the dominance of interests, but to record it in the hope of better understanding policy. In the process, we cannot help but find the opening epigraph by David Hume more helpful than Keynes’s belief in the fragility and malleability of human thought and behavior.

The next six chapters explore the interests, ideas, and practices of fiscal and monetary policies. The general conclusions are quickly summarized. Economists dismiss the public’s disapproval of the national debt as Deficit Hysteria (Benavie 1998) which fails to comprehend scientific explanations that public debts are like private debts, they arise from spending that promotes stabilization and growth, and the government’s net worth is positive, anyway (Samuelson 1958: 350–62; Eisner 1986).

Opposed to this view of government budgets as applications of economic theory—instruments of macroeconomic policy—is the experience of tax conflicts that is virtually the history of the development of democratic government. Taxes have been about wealth and power, about government, in fact. We should be surprised if the powers for which interests have fought so long and so hard were given away to experts ‘who have never won a precinct’. ‘When you have decided upon your budget procedure you have decided on the form of government you will have as a matter of fact’ (Fitzpatrick 1918). The pessimistic implications of the story told in Chapter 2 for the practice of discretionary stabilization policy are clear, and are shown in Chapter 4 to be realized.

The story of monetary policy is similar, although knowledge plays a greater part in its telling. Interests cannot be separated from knowledge. Central bankers, who function in the environment of the financial markets and have inherited with their banker cousins the belief that sound money is good for themselves and necessary to economic stability, resist the temptations of more removed and ambitious goals. They follow their interests, as they feel and understand them, as much as the congressmen who tax and spend. The money-market myopia of central bankers that is vilified by economists finds no place in monetary theory but explains their behavior. Fluctuating inflations have been due to governments wanting cheap finance—sometimes rationalized by equally fluctuating economic theories—rather than to instability in the knowledge or preferences of central bankers.

It is worth emphasizing that interests and customs are not the only impediments to the application of theory. The communication of knowledge is also fraught with difficulties. Even the understanding of a new theory—before its application can be considered—requires the breach of difficult, although sometimes invisible because they are in the mind, obstacles. The dissemination of theory among intellectuals might be thought a low hurdle, but it is seldom accomplished. Rhetoric is easy (‘We are all Keynesians now.’), but intellectuals are as liable as practitioners to mold ideas in their own interests. Economists’ rejection of Keynes’s difficult general (including disequilibrium) theory of an uncertain money economy, preferring the familiar certainty-equivalent equilibrium of a costless real economy, is the subject of Chapter 3. The ‘Keynesian revolution’ is a case study of the difficulties of communication between groups in the policy chain.

Making the next step, although the purportedly Keynesian economists accepted (many had anticipated) Keynes’s interventionist policy proposals, they had little influence on political minds. Applications even of the severely modified form that economists found tractable would have had to survive a complicated and itself uncertain political process that depends on the attitudes and energies of voters and their representatives attempting to manipulate viscous institutions.

The fundamental attitudes of policymakers—politicians and central bankers—have been distant from economic theory, and resistant to the volatile intellectual efforts to change them. The improvement in monetary policy the last three decades in fact has consisted of the government’s subordination to the more persistent preferences of central bankers. Theory followed the Fed more than the other way around.

Chapters 5–7 do for monetary policy what Chapters 2–4 did for fiscal policy, giving a history of monetary policy that is another study in the stability of behavior, the mainly sensory determinants of that behavior, and an account of the persistent beliefs and conduct of the Federal Reserve.

Interests are probably sufficient barriers to the application of theories but the barriers are raised by the difficulties of communication—of the transmission of ideas between minds molded by divergent backgrounds, environments, and interests. Theorists and ‘practical men’ possess fundamentally different—closed vs. open, certain vs. uncertain—visions. The British empiricist philosophers and American pragmatists help explain a good part of the intellectual gap in terms of sensory differences arising from different experiences and environments which generate distinct ideas as well as interests. There are good reasons for the significant and enduring resistance of policy to theory. This book is not an argument that macro-policies ought to be conservative but rather a discussion of the forces that make them so.

Not all economists have believed that policies are straightforward applications of theory. Alfred Marshall distinguished ‘economics’ and ‘political economy’, the former being a science available to all regardless of ethical or political views. He believed that the coupling of ‘political’ with ‘economics’ wrongly implied ‘political interests’ that ‘the practical man [distinct from the economist/scientist] cannot ignore’ (Marshall 1920: 36; Marshall and Marshall 1879: 2; Cannan 1922: 43).

Marshall’s interventionist successors have been unable to resist the mixture. Theories are explanations of economic relations that abstract from political, institutional, and cultural complications. However, the temptation to project theories onto actual economies has been irresistible. The distinctions between ‘positive’ and ‘normative’ economics, that is, between simplified general explanations and their applications to specific problems are often discussed but seldom taken seriously.

The field of ‘public choice’ is available to help qualify the exaggerated trust in the practical power of theory, but ‘most economists have chosen to ignore the interaction between economic policy and politics’ (Laffont 2000: 5). This book does not try to overcome these great problems by modeling the interactions. I only record that the practical influences of theory are small. Interests dominate policies, and largely mold the theories that rationalize them.

This does not mean that economic theory is uninteresting or useless. On the contrary, it provides considerable insights into economic relations. An example is its demonstration of the benefits of free trade, about which, probably more than any other issue, economists agree. So why don’t we have free trade? The usual answer is in terms of interests realized through the political process (Riezman and Wilson 1995). Shouldn’t this apply to other—fiscal and monetary—theories, as well?

Part I
Fiscal policy

2 Interests

A history of tax conflicts

When a fellow says it hain’t the money but the principle o’ the thing, it’s th’ money.

(Hubbard 1920)

Politics, n. A strife of interests masquerading as a contest of principles.

(Bierce 1911)

This chapter is a history of tax conflicts in England and the United States. I do not consider the efficiency of taxes directly but examine the interests affecting their adoption and collection. The history of taxes is also the history of the development of democracy. Property rights are personal rights. In his second Treatise of Civil Government, the ideas of which ‘the principles of the American Revolution were in large part an acknowledged adoption’ (Carpenter 1924: 180), John Locke wrote: ‘The great and chief end … of men uniting into commonwealths, and putting themselves under government, is the preservation of their property’ (1690b: 180).

The political and social relations between groups of various locations and endowments have played important parts in tax struggles. The purpose of a tax may have been broadly national or imperial but its effectiveness was molded by the detailed political and social fabric of the nation or empire—of the English counties, the colonies, and in the new republic, the conflicting interests of enterprise and geography.

The keen, even violent, interests in government budgets belie those who would dismiss them as ‘symbolic’ or instruments of control. Governors and governed understood that wealth and power were at stake (Savage 1988: 7).

it has long been recognized that the history of taxation is the history of ‘the English constitution expressed in economic terms’, and that ‘the English constitution was developed by the necessaries of taxation’.

(Dietz 1928)

The most famous as well as the most important episodes in the eternal conflict—the only certainties are death and taxes—are summarized in mostly chronological order. I am interested primarily in modern American fiscal policy, but since369258147036925 American law and experience have grown out of the English, it is useful to begin with the Great Charter of 1215, before moving to the contest over Ship Money that led to the Civil War of the 1640s, the struggle over control of the public purse that was decided by the Glorious Revolution of 1688, and the Stamp Act and other differences between Great Britain and its American colonies leading to the War of Independence. These were followed by tax conflicts in the new republic when citizens sought to apply the principles of the Declaration of Independence from Great Britain to themselves vis-à-vis their state and federal governments. The most enduring tax conflict in the United States has been over tariffs. The continuing debate over defense spending and its finance is close behind. Disputes over both arose in the 1790s, and continue. Taxpayers do not always oppose taxes, such as during the ‘missile gap’ of the 1950s, when Congress complained that the president was not asking enough for defense.

These are not all the important tax conflicts, but I hope they will be sufficient to show why the economic implications of Keynesian stabilization theory were not accepted, or even considered by politicians or taxpayers, as opposed to intellectual activists. Even if the theory had been accepted, too much was at stake for economic and political interests to yield control.

The Magna Carta

If any earl, baron, or other person that holds lands directly of the Crown, for military service, shall die, and at his death his heir shall be of full age and owe a ‘relief’, the heir shall have his inheritance on payment of the ancient scale of ‘relief’. That is to say, the heir or heirs of an earl shall pay £100 for the entire earl’s barony, the heir or heirs of a knight at most £5 for the entire knight’s fee, and any man that owes less shall pay less, in accordance with the ancient usage of ‘fees’.

Thus runs a translation of the second clause of the Great Charter that King John was compelled to accept by the nobles assembled at Runnymede, outside London, in 1215. John’s imagination and ruthlessness in finding and collecting taxes, primarily for military efforts to retain his lands in France, had aroused dissension among the nobles, and his failures, especially the loss of Normandy, had reduced his status and opened the way to successful resistance.

The clauses are not numbered in the charter, but of the 63 issues that are usually identified, most are restrictions on the king’s authority to command resources (Jennings 1965: 44–7). Prominent are limits on regular taxes, such as the inheritance fees noted above, and special levies for the king’s military ventures. Procedures for assessing taxes are also specified, as in clause 12:

No ‘scutage’ [payment in lieu of military service] or ‘aid’ may be levied in our kingdom without general consent, unless it is for the ransom of our person, to make our eldest son a knight, and (once) to marry our eldest daughter. For these purposes only a reasonable ‘aid’ may be levied.

Clauses on the administration of justice sought to secure property from arbitrary seizure. Court fines were limited to amounts ‘in proportion to the degree of the offence’, in the judgment of ‘reputable men of the neighbourhood’ (clause 20), and ‘ordinary lawsuits shall not follow the royal court around, bu...

Table of contents

• Cover Page
• Title Page
• Copyright Page
• List of figures
• List of tables
• Acknowledgments
• 1 Introduction
• PART I Fiscal policy
• 3 Ideas: the theory of stabilization policy
• 4 Practice: the stability of Federal government deficits
• PART II Monetary policy
• 6 Knowledge, advice, and monetary policy
• 7 The stability of monetary policy: the Federal Reserve, 1914–2007
• PART III Conclusion
• Notes
• References