he heroes of Robert J. Samuelsons The Great Inflation and Its Aftermath: The Past and Future of American Affluence, a reflection on the troubles of the 1970s, are Paul Volcker, Federal Reserve chairman from 1979 to 1987, and Ronald Reagan, U.S. president from 1981 to 1989. The goats are the British economist John Maynard Keynes, dead since 1946, and his followers, especially the late John Kenneth Galbraith (19082006), the father of this reviewer. Galbraith pre stands in here for a raft of postwar Keynesians whose names appear in the book only briefly, especially Paul Samuelson (no relation to the author), James Tobin, and Robert Solowall Nobel Prize winners, and the real architects of the Keynesian consensus of those years.

The American Keynesians knew that unemployment could be conquered by the simple policy of spending, both public and private; for them this was the great lesson of World War II. They also conceded that inflation would have to rise a bit to sustain full employment. Most thought this would be acceptable, a price worth paying, though my father, an inveterate price controller from his war days, did not agree. On the right, and nearly alone in those years, University of Chicago economist Milton Friedman also dissented. Friedman held that the drive for full employment would produce not higher inflation but hyper inflation: an
acceleration in price increases leading to monetary collapse.

In Robert Samuelsons eyes, the Great Inflation of the 1970s vindicated Friedman. The Keynesians were not just wrong, they were culpable, having broken the basic laws of economics. Collapse was on the way. But the country was saved by Volcker and Reagan: the former because he had the courage to act, inflicting great pain, to bring inflation down, and the latter because he supported Volcker just long enough. Once inflation fell, there was a happy ending, summarized in one of Samuelsons chapter headings: “Capitalism Restored “

It is true that the Keynesians were in crisis by the time Volcker came in. They had failed to prevent rising inflation in the 1960s, and their concept of a stable trade-off between inflation and unemployment (famously known as the Phillips Curve) collapsed in the 1970s. Their fate in academia would be bleak: today their once-dominant ideas are widely disregarded, and taught, if at all, through the prism of their critics.

And yet, why the inflation happened is not as clear as Samuelson believes. He dismisses the effects of both the Vietnam War and the oil shocks. He hardly discusses the global character of inflation in those years, which alone suggests that something more than the ideas of Cambridge and New Haven dons was involved. We are asked to believe that, compared to the “obsession with full employment,” these things were not important. Never mind that war has always been inflationary, that the collapse of Bretton Woods came in 1971, and that OPEC certainly seemed like a pretty big deal in 1974 and 1979.

And if the inflation were due mainly to war or oil prices, then after a certain amount of time, and with some help from incomes policy, it might simply have receded. For Samuelson, this possibility cannot be admitted. Otherwise, there is the awful chance that the super-tight money, the high interest rates, and the deep recession of the early 1980s werent necessary. The renewed application of less drastic measures might have been enough.

Those of us who opposed the policy in 1981 believed this was so. I was, at the time, executive director of the Joint Economic Committee, where I drafted the Balanced Monetary Policy Act of 1982, which Samuelson describes accurately as an effort to form a left-right coalition against the Feds policy. And Volcker did back off, in August 1982, when the recession seemed bottomless and the Mexican default threatened to bring down the U.S. banking system. Whether our threatessentially to start dictating interest rate policy from Capitol Hillwas a factor is hard to tell. But the Feds congressional liaison did call me, at one point, to ask what it was we really wanted. I told him that if interest rates started to fall, our threat to the central banks independence would probably go away.

After 1982 Keynesianism in academia was done for, but in the policy world it was not. Policymakers are practical. They recognize that voters dislike unemployment and that recessions are unpopular. The political instinct remains to react to recessions with a “stimulus package.” Under Republican presidents, at least until this year, this policy was usually called “supply-side economics”Reagan was a great practitioner of it, as was George W. Bush in 200104. This is short-term Keynesianism in disguise, always accompanied by professions of budget piety and promises that “fiscal responsibility” will return as soon as normal conditions are restored. But it is Keynesianism nonetheless. It is government intervention to support total spending, and especially the use of public spending power, in the military or elsewhere, to bring the economy out of a ditch. Samuelson turns a blind eye to the actual conduct of policy after 1982, writing as though the ideal rather than the practical had prevailed. He argues that stimulus produces inflation rather than growthdespite the fact that even under Reagan and Bush II it did not.

But then, in Samuelsons view recessions are inevitable. Trying to fix them is futile. Left alone, the economy always recovers; the cost of waiting is small; the job of the Federal Reserve is to stop inflation; the job of the rest of the government, at least in the macroeconomic domain, is to do practically nothing at all. “Just because something isnt perfect,” he writes, “doesnt mean it can be improved.” (Given these views, expect him to start in January, if not sooner, demanding that Ben Bernanke quash the forthcoming Obama expansion program with high interest rates.)

Samuelson favors the notion that unemployment should never be allowed to drop below its “natural rate”estimated for much of the 1980s at between 6 and 7 percentlest inflation get out of control. That precise numerical proposition was singularly open to be tested against fact. And in the late 1990s, thanks to Alan Greenspans tolerance for bubbles, it was tested: joblessness fell to under 4 percent for three years. No rise in inflation happened. This good fortune cant be explained by the Phillips Curve. But it also cannot be explained by the natural rate theory Samuelson favors. This raises the possibility that both sides of that argument were mistaken. Maybe full employment by itself doesnt produce inflation after all. Back in the 1960s, only a tiny handful of economists (including the first Council of Economic Advisers chair Leon Keyserling, Robert Eisner, Nicholas Kaldor in Britain, and my father) would have admitted to holding that view. But they were right.

Similarly, if the conquest of inflation in the 1980s meant “Capitalism Restored,” how did the great bust happen? Samuelson is aware of bubbles, and mentions them here and there. But on the whole he treats them as a minor matter. He favors private debt, and celebrates the rise in homeownership to 68 percent of the population even while conceding that perhaps the sub-prime mortgage markets “went too far.” When it comes to discussing current policy problems, his head is stuffed with the alleged budget dangers posed by Social Security (more or less that keeping our promises to the elderly will drive up long-term interest rates), with the “risk” that universal health care might someday be enacted, and with hypothetical consequences of backlash against globalization. He even frets that we might get serious about climate change, making terrible mistakes that would undermine our economy today in the pursuit of survival for people elsewhere a century hence (imagine that). He is caught for the most part unaware, flatfooted and with his pants down, by the great financial crisis of 200708 and counting.

A useful theory must account for the problems of the world. Samuelsons theory, his worldview in a nutshell, holds that a rigorous anti-inflation monetary policy is sufficient for good economic performance. While occasional recessions may be inevitable, he believes that the credit markets do not cause them: they are naturally stable so long as policymakers dont make inflationary mistakes. And this is not his theory alone. It is the mainstream position of the entire academic economics profession right now. (Indeed, The Great Inflation and Its Aftermath is a very good, plainly written account of what a great many reputable people believe.)

With a “credible” anti-inflation policy in place, even though the exact content of that policy may not be clear, Samuelson and his fellow travelers believe that free markets will do the rest. Regulation, in particular of credit, is a burden, something to be minimized. “Market discipline” is sufficient to keep fraud, abuse, and mayhem under control. Along with many others, Samuelson cites the wonderful quarter century, roughly from 1981 through 2006, as the final and absolute proof of this wisdom.

[I]t was a self-inflicted wound: something we did to ourselves with the best of intentions and on the most impeccable advice. Its intellectual godfathers were without exception men of exceptional intelligence. They were credentialed by some of the nations outstanding universities … But their high intellectual standing did not make their ideas any less impractical or destructive.

As a general proposition about economic events and academic ideas, these words carry the awful ring of truth. But they should be uttered with extreme caution. Passages such as this have an unpleasant tendency, at moments like the present, to come back around, and bite their author on the ass.

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James K. Galbraith

James K. Galbraith is the author of Welcome to the Poisoned Chalice: The Destruction of Greece and and Future of Europe, forthcoming from Yale University Press.