Opinion Editorial | |
| Wednesday, September 1, 1999 | |
Candidates Criticize Keynesianism at the Federal Reserve |
For 50 years, the theories of economist John Maynard Keynes dominated economic thinking. One of the pillars of Keynesian theory is the Phillips Curve, which shows that there is a trade-off between inflation and unemployment. Low unemployment leads to high inflation, and high unemployment reduces inflation.
In the 1970s, Keynesian economics collapsed. It could not explain nor prescribe any solution to the problem of simultaneously rising inflation and unemployment. This led to a reassertion of pre-Keynesian neoclassical economics that almost all economists accept today. At least in academia, Keynesian fine-tuning is dead.
Unfortunately, Keynesian theories are still alive and well in two important places outside academia: the Federal Reserve and the bond market. Both still believe strongly in the Phillips Curve and worry endlessly that unemployment is too low and will soon trigger another outbreak of inflation. Ever since the unemployment rate broke the 5 percent barrier in May, 1997, the neo-Keynesians have been expecting another burst of inflation. Yet inflation is nowhere to be seen, and all the leading indicators of inflation are signaling continued moderation in prices. Nevertheless, the Keynesians in the bond market have now pressured the Keynesians on the Federal Open Market Committee to raise interest rates by 50 basis points (one half of a percentage point) to keep inflation in check.
Certainly, no one wants to go back to the bad old days of the 1970s, and on balance there is no question that Federal Reserve Chairman Alan Greenspan has done an excellent job. But Fed policy is a legitimate issue of political debate and it is appropriate for presidential candidates to spell out their thoughts about monetary policy. So far, the leading candidates of the two parties, Democrat Al Gore and Republican George W. Bush, have committed themselves to supporting Greenspan without reservation. However, both Steve Forbes and Dan Quayle are pressuring Bush on the issue, and Bill Bradley may do the same to Gore.
Last week, after the Fed's latest tightening move, Forbes blasted the action as based on a "flawed and disproven theory that prosperity causes inflation" (i.e., the Phillips Curve). Deflation, he said, "is far more of a danger, as any American farmer can tell you."
On Saturday, Quayle went after Greenspan, criticizing remarks he made at a Fed meeting in Wyoming suggesting that if stock prices go too high this could also trigger further Fed tightening. "I can no longer understand how the entire political establishment can sit back in a state of paralysis while Alan Greenspan lectures the nation on the need not only to subdue economic growth, but also to rein in the stock market," Quayle said. He suggested that Greenspan consider early retirement.
George Bush, on the other hand, voiced support for the Fed's latest action and reiterated a desire to reappoint Greenspan to another term as Fed chairman. Gore and Bradley had no comment.
This argument may seem esoteric to the Washington press corps, which is intent on making its agenda of campaign finance reform and gun control the major issues in the presidential race. But the farmers of Iowa know very well that monetary policy is an issue that strikes at the heart of their livelihood. Commodity prices rise and fall on Fed actions, and lately prices have been very weak indeed. This means that Forbes and Quayle are at least going to get a respectful hearing in Iowa and it may put Bush on the defensive. If they draw blood, we may see Bradley take after Gore on the same issue. It will be interesting to see how Bush and Gore respond.
Source: Bruce Bartlett, senior fellow, National Center for Policy Analysis, September 1, 1999.
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