EC Have Economists Learned Nothing Since The 1970s?

Judging by Ambrose Evans-Pritchard’s 15th March article in the Financial Times, which rehashes the most popular economics-related fallacies of the 1970s, the answer to the above question is a resounding NO.

Here’s an excerpt from the article that neatly encapsulates the ideas that were widely believed by economists during the 1960s-1970s, that were shown to be false during the 1970s, and that are now apparently again accepted as true:

Every major downturn since the First World War has been caused by the Fed, determined to snuff out inflation as the credit cycle matures. Expansions rarely die of old age. They are killed.

There may have been other factors in each historical episode — the oil shocks of the 1970s, or the first Gulf War in 1991 — but the Fed has been the determining catalyst each time.

Mr Fischer could hardly have been clearer. He spelled out why the 1970s ‘Phillips Curve’ trade-off between unemployment and inflation is alive and well, and an implicit warning that prices could soon take off since the labour market is clearly approaching the electric fence of Milton Friedman’s NAIRU (non-accelerating inflation rate of unemployment).

The fact is that the Fed does cause severe economic downturns, but not by tightening monetary policy. In the real world, every boom that occurs on the back of money-pumping and interest-rate suppression contains the seeds of its own destruction. The reason is that the falsification of prices resulting from the central bank’s efforts to stimulate economic activity leads to widespread malinvestment.

Once the malinvestment occurs, a painful period of adjustment becomes inevitable. As Mises explained about 100 years ago, the only question is whether the adjustment begins sooner as a consequence of deliberately slowing the pace of money-pumping or later as a consequence of a collapse in confidence in the money. Politicians naturally want the adjustment to happen later (after the next election or, best of all, on somebody else’s watch), but the later it happens the more painful it will be.

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Gary Anderson 3 years ago Contributor's comment

Author says: "The fact is that the Fed does cause severe economic downturns, but not by tightening monetary policy. In the real world, every boom that occurs on the back of money-pumping and interest-rate suppression contains the seeds of its own destruction. The reason is that the falsification of prices resulting from the central bank’s efforts to stimulate economic activity leads to widespread malinvestment."

I agree with that, because risk was mispriced. But we know that the Fed failed to make up for the destruction of the commercial paper market and for the pulling of Heloc credit by failing to increase the money supply. So, the Fed probably made the recession much worse by not taking action to make up for that obvious shortfall. The Fed knew that GDP was crashing and just did nothing.

It is the Market Monetarists who correctly pointed this out, not the Keynesians.

Doug Morris 3 years ago Member's comment

Good points.

Gary Anderson 3 years ago Contributor's comment

One more point, it is clear that inflation was continuing, while GDP was falling, in 2007-8. So by monitoring inflation and by ignoring GDP decline, the Fed simply allowed the economy to be ruined. That probably was unnecessary. Look at house prices. They have bounced back, only the middle class doesn't own them now, the wealthy investors do. That seems conspiratorial to me.