The Surrender of Economic Policy

By Galbraith, James K. | The American Prospect, March-April 1996 | Go to article overview

The Surrender of Economic Policy


Galbraith, James K., The American Prospect


There is a common ground on economic policy that now stretches, with differences only of degree, from the radical right to Bill Clinton. Across the spectrum, all declare that the main job of government is to help markets work well. On the supply side, government can help, up to a point, by providing education, training, infrastructure, and scientific research--all public goods that markets undervalue. But when it comes to macroeconomic policy, government should do nothing except pursue budget balance, and leave the Federal Reserve alone.

To accept a balanced budget and the unchallenged monetary judgment of the Federal Reserve is, by definition, to remove macroeconomics from the political sphere. Thus, the remaining differences between Clinton and tile Congress are over details. Should we head for budget balance in seven years, eight, or ten? Should we cut (or impose) this or that environmental regulation? Do lead Start, the AmeriCorps, and technology subsidies justify their cost? And so on, in long litanies that no one believes will make a fundamental difference in American lives. Even if there were substantial gains to be made by public investments on the supply side, the conservative fiscal consensus precludes them by denying the resources.

We have now seen two Democratic presidents--Carter and Clinton--deeply damaged because they did not dispute this orthodoxy in good time and therefore could not control the levers of macro policy. Macroeconomics, not microeconomics, is the active center of power. Practical conservatives understand this. It is no accident that conservatives always seek to control the high ground of deficit and interest rate policy, nor any surprise that liberals defeat themselves from the beginning when they concede it.

Yet, the economics behind this consensus is both reactionary and deeply implausible. It springs from a never-never-land of abstract theory concocted over 25 years by the disciples of Milton Friedman and purveyed through them to the whole profession. Liberals--and anyone else concerned with economic prosperity--should now reject this way of looking at the world.

THE RIGHT-WING CONSENSUS ON EMPLOYMENT AND INFLATION

The conservative macroeconomic creed is built on three basic elements. They are, first, monetarism--the idea that the Federal Reserve's monetary policy controls inflation, but has little effect on output and employment except perhaps in the very short run. Second, there is rational expectations, which is the idea, for which Robert Lucas just won the Nobel Prize, that individual economic agents are so clever, so well informed, and so well educated in economics that they do not make systematic errors in their economic decisions, especially the all-important choices of labor supply. And third, there is market clearing: the idea that all transactions, including the hiring and firing of workers, occur at prices that equate the elemental forces of supply and demand.

Taken together, these assumptions conjure an efficient labor market that yields appropriate levels of employment and wages. The employment level generated by this abstraction is the core policy concept of mainstream macroeconomics, known as the natural rate of unemployment.(*) If unemployment is above the natural rate, the theory dictates that prices and wages will fall. If unemployment is below the natural rate, the theory dictates that inflation will rise. Sustainable, noninflationary employment growth occurs only at the natural rate. [See Robert Eisner, "Our NAIRU Limit: The Governing Myth of Economic Policy," TAP, Spring 1995.11

Among most economists these ideas are amazingly noncontroversial. The only dispute is over a narrow point of policy--whether there is any value in attempts to steer the economy toward the natural rate if it happens to be, for a time, either above or below it. To the strictest natural-raters, doing nothing is always and everywhere the right prescription, because the economy will always return to the natural rate on its own. …

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