Economic Follies of the 1960s Echo in the 2012 Presidential Campaign
The 2012 presidential campaign is gaining momentum. Both sides agree that the economy will be the central issue. Mitt Romney is promising to get unemployment down to 6 percent by the end of his first term and eventually to 4 percent. Barack Obama is hesitant to set a numerical target, having been burned doing that early in his term, but he makes it clear he thinks he can do better than the GOP candidate. I hear echoes of the 1960s, when John Kennedy won the presidency with a promise to get the country moving again. It may be a good time to take a look back at that period.
What was it like in the 1960s? In a recent blog post, Ed Yardini, describing himself as a “recovering macroeconomist,” recalls his days as a doctoral student at Yale. He remembers being taught that everything Milton Friedman ever wrote was wrong, but never being required actually to read any of it. Most of all, he remembers being taught that the job of a macroeconomist was to meddle.
That’s what macroeconomists are trained to do. Without our meddling, the economy wouldn’t perform very well. Indeed, it would fall into recessions on a regular basis, and might never come out without our help. You see, we are superheroes. Like the Hulk, we are scientists with amazing powers to lift an entire economy out of a ditch and back on the road to prosperity. Our professors taught us how to use very sophisticated mathematical models to design just the right mix of fiscal and monetary policies to manage the economy.
I wasn’t at Yale quite when Yardini was, but I don’t think we missed by much. What he says pretty much coincides with what I remember from being there in the late 1960s. We were taught the art of meddling, that’s for sure, although I remember the favored term as “fine-tuning.” The economy was not so much a car in the ditch as a balky TV that needed its rabbit ears tweaked by a well-trained expert.
Among the superheroes of that time were Gardner Ackley, Otto Eckstein, and Arthur Okun, three of the most distinguished economists ever to sit on the Council of Economic Advisers. In their 1966 Economic Report to the President, they wrote
It is now within our capabilities to set more ambitious goals. . . We strive to avoid recurrent recessions, to keep unemployment far below rates of the past decade, to maintain price stability at full employment . . . and indeed to make full prosperity the normal state of the American economy. It is a tribute to our success . . . that we now have not only the economic understanding but also the will and determination to use economic policy as an effective tool for progress.
So, how did it work out, all that masterful fine-tuning? Pretty well, at least at first. This chart shows what unemployment and inflation looked like in the Kennedy-Johnson years. It looks a lot like a Phillips curve, doesn’t it? Twist those knobs labeled fiscal policy and monetary policy, and you can choose just the point on the policy menu that you prefer. If you would like to accept a little more inflation, that’s fine, and you’ll get a nice reduction in unemployment in return.
Toward the end of the 1960s, however, things started to go wrong—things that were never mentioned in our macroeconomics class, or, if mentioned at all, were glossed over with wave of the hand.
First, there were policy lags. We learned that there were lags in IS-LM model, of course, but only as a concept; no calendar time was ever given for them. We would have been astonished to learn that the response time after turning the monetary and fiscal policy knobs was on the order of two full years for real GDP and longer than that for the price level.
Then there were forecasting errors. Computers were in their infancy. The one I ran my dissertation models on occupied a room the size of a basketball court and had about the same computing power as my microwave does today, but we were in awe of them. One of the things they did most awesomely was crank out forecasts based on fleshed-out versions of the IS-LM model. We would have sunk into shocked disbelief if we had been told that those forecasts had no greater accuracy than the assumption that next year would be exactly like this year.
Most insidious of all, there was time-inconsistency. I don’t remember ever encountering that concept at Yale. Time-inconsistency is one of those clunky terms economists use to talk about things we are familiar with from everyday life, in this case, the fact that people sometimes pursue short-term objectives that are different from their long-term best interests. The classic case is the decision of whether to have one more drink before you leave the party. Economic stimulus just before an election is equally a classic.
The macroeconomic superheroes of the day were not supposed to be subject to time-inconsistency. Remember, “We now have not only the economic understanding but also the will and determination to use economic policy as an effective tool for progress.” If only.
When you put lags, forecasting errors, and time-inconsistency together, you get something much nastier than a Phillips curve. You get a stop-go cycle with an inflationary bias. You keep the expansion phase going too long, because you don’t want to take the bitter medicine of disinflation until after the next election. Then, like a poorly disciplined patient with drug-resistant tuberculosis, you stop taking your disinflation pills as soon as you feel a little better, but before the cure is complete. The cycle goes around and around. The top of each cycle has a higher rate of inflation than the one before, and the bottom has a higher rate of unemployment. Here is the full chart of how things played out after those early days of seemingly successful meddling in the early 1960s. Taking the 1960s and 1970s as a whole, it looks like the macroeconomists of the day were less the superheroes who lifted the car out of the ditch than the impaired drivers who put it there.
The take-away for 2012? Beware of macroeconomic meddlers. To their credit, the current generation of economic advisers and policymakers—the Larry Summers, the Greg Mankiws, and most of the rest—are well aware of the pitfalls posed by the terrible trinity of lags, forecasting errors, and time-inconsistency. They know that the ideal is to follow preset policy rules, and if they can’t bring themselves to do that, that they should tweak the policy dials only a little at a time and wait cautiously to see what happens. Some of them may score pretty high on the self-esteem scale, but none of them are as recklessly overconfident as the macroeconomic superheroes of the 1960’s appear, in retrospect, to have been. But they are only advisers. Their clients still face the temptation to meddle.
Obama definitely has some of the instincts of a meddler. They are exemplified by his technocratic attempts to fine-tune environmental and energy policy with a CAFE standard here, an electric car subsidy there, and half a pipeline somewhere else. His 2009 stimulus program was somewhat in the spirit of the 1960s, although it ended up doing neither much harm nor much good. Whether you thought it was too much or too little is moot; Republican opposition is likely to preclude any repetition in a second Obama administration, if there is one.
Macroeconomic management under a possible Romney administration is more of a cause for concern. The candidate’s call for a 4 percent unemployment rate—a goal “far below rates of the past decade”—makes me nervous. Getting to that goal, if it is more than just empty campaign rhetoric, would require boosting real GDP well above its long-term potential.
Somehow, the economic meddlers of the day, whether Republican or Democratic, never see a boom for what it is. Instead, they see it as a new normal of endless prosperity, just as the 1966 Council of Economic Advisers did. If the Bush years taught us anything, it is that Republican vows of responsible fiscal policy go out the window under boom conditions. Even if a Romney administration did manage to bring the budget into balance, that would not be enough at the peak of the business cycle. A 4 percent unemployment rate, if such a thing were ever again to come about, would call for a substantial budget surplus plus monetary restraint. Otherwise, we would get more overheating and another crash.
Could we count on a Republican White House backed by a Republic Congress to avoid the siren call of time-inconsistency? Or would we end up with a new boom-and-bust cycle different from, but no less destructive than, that of the 1960s and 1970s?
13 Responses to “Economic Follies of the 1960s Echo in the 2012 Presidential Campaign”
I think that a return of Nominal GDP to the trend of the Great Moderation could substantially lower unemployment and it could occur rapidly. All that is needed is a Fed that has a new target.
As for Romney, I would only worry if his answer to decreasing the unemployment rate was increasing the growth rate (or even raising the growth path) of nominal GDP.
Supply-side policies aimed at reducing the natural unemployment rate to 4% are fine by me.
Yes, I agree, an NGDP target is just the kind of rule that would help keep the "terrible trinity" under control. I haven't heard either candidate endorse it, but some of their advisers may be well-disposed. Do you know if that is the case?
With regard to supply-side measures: Yes, true supply-side measures to lower the unemployment rate would be welcome. The problem is, during a boom, those in power are likely to attribute low unemployment and high output to their supply-side measures. That is why they call the boom a new normal. For example, in the Bush administration, some optimists attributed the strong economy to structural changes, like lower tax rates that encouraged entrepreneurship and financial innovations that supposedly increased the efficiency of allocation of capital. They forecast that the boom would go on forever, so they were not worried about the fact that cyclically adjusted deficits remained unsustainable. In fact, it was just a plain old boom fueled by unrealistic tax policy and unbudgeted war spending. In the Clinton boom, same thing–people wrote that the Internet had changed everything so that stock prices, employment, and all were in a new normal. It could happen again, regardless of who is president, but I see the danger as being greater under Romney, especially if the GOP captures both houses of Congress so that there are no checks and balances on tax cuts and spending boosts. And yes, Republicans do like to spend, too, just on different things.
Another factor: global oil production doubled between 1945 and
1960, then doubled again by 1970.
We won't see that again. Indeed, even a further 10% increase may
not be in the cards.
its funny – the skepticism of the ability of a Republican controlled Congress/white house to control spending appears to me to be a generational thing. It's the younger crowd IMO that genuinely think they can keep the fiscal discipline and faith. Age and experience makes one <del>more cynical</del> <ins>wiser</ins>. There are extremely powerful incentives for Congress-people to demonstrate that they can bring home the bacon to their constituents, in order to get re-elected. The fiscal discipline usually last about as long as the election cycle.
oh, and one of the merits of NGDP targeting is that it makes it extremely transparent what the Fed is going to target. We all know at full employment the Fed tries to offset fiscal policy, but i think making this transparent transforms the fiscal debate to "how much of the pie does the govt want to eat" rather than the appearance that the govt can create more pie by spending.
Economists, what cards! Do you actually believe that the main reason for the marked slowdown in economic growth after the early 70s was American economic policy? What we have here is the reverse of the old bit about the rooster taking credit for the sunrise. The liberal economists of the 50s and 60s took too much credit for the enormous expansion that occurred after WWII and then were assigned too much blame when it came to an end. Same error both ways.
Of course we also see evidence of other forms of silliness in this essay, most notably the apparent assumption that the Republicans give a damn about balance budgets or make lowering unemployment a priority. Caring about the public good is the merest Communism, damn it! To be more specific, you'd think that somebody of Dolan's vintage would have noticed that it has been Republican administrations that have exploded the national debt over the last 40 years while the Democrats have typically been left to try to limit the damage to the public finances guaranteed by policies designed to increase economic inequality.
"You'd think that somebody of Dolan's vintage would have noticed that it has been Republican administrations that have exploded the national debt over the last 40 year"
It's a pity you didn't read more of the post. You might have liked the parts where I said "Republican vows of responsible fiscal policy go out the window under boom conditions" or where I suggested that Romney's unemployment goals might be "empty campaign rhetoric."
I read the whole post. The bit about "Republican vows of responsible fiscal policy go out the window under boom conditions" assumes that the Republicans would like to be responsible about fiscal policy but are seduced into violating their own principles by the heady atmosphere of boom times or temporary political expediency. In fact, the Republicans aren't engaging in "empty campaign rhetoric." They are lying. Wrecking public finances has been a part of a program to destroy the welfare state for umpteen years now. They haven't exactly been keeping that plan a secret.
General problem: economists who act as if moral and political conflicts were disputes about economic technicalities instead of fundamental values and competing interests.
"Republicans would like to be responsible about fiscal policy but are seduced into violating their own principles by the heady atmosphere of boom times or temporary political expediency"
You've got it. Yes, that's what I am assuming.
Did I really just read a long, cautionary analysis of meddling by overconfident economists followed by a straight-faced discussion of how ever-more-extreme meddling (NGDP targeting) is just what we need?
It's always tricky to say which Party gets credit for balanced budgets and which is blamed for profligate spending. Arguments tend to follow one's own political bias. Usually, I favor libertarians, but I also liked those few cost-cutting mid-1990s Republicans who leaned closer to freedom than addictive spending (ala Bush, Jr.). In my view, the 1990s featured a unique productivity surge from the end of the Cold War and the concurrent proliferation of the Internet and other new technology. Politically, the Republican Revolution of 1994 put Dick Armey and Newt Gingrich in charge of crafting budgets in the House. Contra the reigning myth of "Clinton balancing the budget," perhaps Dick Armey and his gang should get equal credit with Clinton, along with at least a nod to the Internet's birth and the Cold War's death, similar one-time events to the end of World War II and postwar prosperity.
I'd be interested to to know, just what kind of monetary policy you think involves the least amount of meddling? NGDP targeting always seemed pretty passive to me, but maybe you like gold or something?
"And yes, Republicans do like to spend, too, just on different things. "
but…but…but its not spending if its *my* project.
"Rep. Michele Bachmann (R-Minn.), founder of the Tea Party Caucus, has said earmarks shouldn’t count when they’re for transportation projects. And just last week, the Transportation panel’s top Democrat, Nick Rahall of West Virginia, made a public plea that Chairman John Mica (R-Fla.) join him in writing a letter asking Boehner to bring back earmarks."
1.57% on the ten year treasury, and a re-election coming up. All we need now is an economist to give them permission to spend, courtesy of a broken Euro.