The fact that maximizing economic growth requires constant government intervention in the economy for the purposes of macroeconomic stabilization policy creates a rhetorical problem for people who believe in free markets. Milton Friedman devised a solution to this problem that, as Brad DeLong notes, though clever has also misled a lot of people. The first step is to deny that discretionary fiscal policy has a legitimate role in macroeconomic stabilization. The second step is to try to pretend that monetary policy is somehow not government intervention in the economy:
In the 1950s and 1960s and 1970s Milton Friedman faced a rhetorical problem. He was a laissez-faire libertarian. But he also believed that macroeconomic stabilization required that the central bank be always in the market, buying and selling government bonds in order to match the supply of liquid cash money to the demand, and so make Say’s Law true in practice even though it was false in theory.
Such a policy of constant government intervention to continually rebalance aggregate demand is hardly a laissez-faire hands-off libertarian policy, is it?
Friedman, however, set about trying to maximize the rhetorical distance between his position–which was merely the “neutral,” passive policy of maintaining the money stock growth rate at a constant–and the position of other macroeconomists, which was an “activist,” interventionist policy of having the government disturb the natural workings of the free market. Something went wrong, Friedman claimed, only when a government stepped away from the “neutral” monetary policy of the constant growth rate rule and did something else.
As a marketing tactic, this was a huge success. But it wound up obscuring from people the fact that there was no real disagreement between a Friedman position and the Keynesian one on the question of whether or not “big government” is charged with boosting demand to re-inflate a depressed economy. And as it happens you don’t need to go back to Friedman to find that, historically speaking, fans of unrestrained capitalism haven’t denied the importance of activist policy as a stabilizing measure. Here, for example, is Frédéric Bastiat on fiscal stimulus in “What Is Seen and What Is Not Seen”:
As a temporary measure in a time of crisis, during a severe winter, this intervention on the part of the taxpayer could have good effects. It acts in the same way as insurance. It adds nothing to the number of jobs nor to total wages, but it takes labor and wages from ordinary times and doles them out, at a loss it is true, in difficult times. As a permanent, general, systematic measure, it is nothing but a ruinous hoax, an impossibility, a contradiction, which makes a great show of the little work that it has stimulated, which is what is seen, and conceals the much larger amount of work that it has precluded, which is what is not seen.
For the country to prosper over time, people on both the left and the right need to have this straight. As I put it in my article on the Fed:
This free lunch is available amidst deep recessions because such events are defined by the widespread idling of resources. A recession means the country has able-bodied people who aren’t working, factories that aren’t running, and office space and storefronts that are vacant. Fiscal and monetary stimulus aims to mobilize that excess capacity. When there is no excess capacity, printing money to keep rates low will simply lead to inflation. The country’s ability to produce money may not be limited, but its ability to produce goods and services is, and inflation is what happens when the government attempts to stimulate demand above the country’s ability to produce. Increasing productive capacity is the key to long-term prosperity, but adequately matching demand to current capacity is the key to the short-term employment and economic growth picture.
People on the right seem to have forgotten the conclusion of this argument, and I worry that we’ve seen over the past three years that all too many of the people on the left who have the right conclusion don’t fully understand the implications. Hence the otherwise baffling neglect of federal reserve policy on the progressive side.