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Bartley's Contemplations

Mises Daily: Saturday, April 14, 2001 by

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Industrial ProductionWhat is it about economic downturns that get mainstream economists and economic journalists into a frenzy?  Robert L. Bartley, the editor of the Wall Street Journal, inadvertently answered this question in his "Talking Things Over" column last week.

"We’ve survived real recessions and real bear markets before," writes Bartley, "yet somehow the current pause has been particularly frightening to a lot of people.  For one thing, it came off years of uninterrupted progress and spectacular growth from mid-1999 to mid-2000, and it also hit rather by surprise.  But the most important reason the downturn is scary, I suspect, is that its cause remains a mystery."

The bigger mystery, in fact, is that the Wall Street Journal editor isn’t clear on the causes of something as fundamental as a business-cycle downturn.  Unfortunately, he is not alone, as the same could be said of many mainstream economists.  These occurrences simply do not fit into their models, and so they remain "a mystery."  And while many thinkers, including Bartley, arrive at quasi-Austrian explanations, they refuse to follow this train of thought to its logical end.  Doing so would require that they favor a paired down monetary infrastructure with a less prominent role for central bankers and economic journalists who lobby them.

Bartley acknowledges the role of poor monetary policies in bringing about both recessions and unsustainable growth in the economy, a role that is well known to Austrians, but he refuses to allow this line of thought to take him beyond the framework allowed by conventional supply-side monetarism.  These swings in the business cycle occur when changes in Fed policy are unanticipated, he writes, while the effects of these policies are manifest two years following their implementation.  

And so, according to Bartley, the current economic downturn is the result of anti-inflationary monetary policies that the Fed implemented in reaction to OPEC price boosts that occurred in the last quarter of 1999.  It follows that we will witness more economic growth in the future resulting from the expansionary policies the Fed has been implementing over the last few months.

It is instructive to look at the thinking that underlies this argument.  The assumption is that the Federal Reserve can know the natural rate of interest and that it maintains this rate of interest by targeting the federal funds rate.  Sure, it sometimes misjudges this rate, resulting in unsustainable or recessionary growth levels in the business cycle, but in the long run, the Fed has the expertise, independence, and technology necessary to get it right most of the time.  

Indeed, Bartley seems to think that the Fed’s current woes, as well as Alan Greenspan’s less-than-stellar popularity, stem from rare Fed policy misjudgments in response to exogenous shocks such as the Asian crisis, the Russian loan default, the Long-Term Capital bailout, and the return of OPEC price power. Bailouts, and the moral hazard they institutionalize, are a problem. But the root issue lies much deeper. 

First, calls for the Fed do a better job at managing the economy assume that a public institution can accurately predict the future.  Financial analyst James Grant discusses this assumption in his book The Trouble with Prosperity.  The suggestion, writes Grant, is that future economic conditions cannot be anticipated "without a preview of the principles of central economic planning, including the idea that the future can be accurately divined by a committee of public servants.  Although this notion, qua notion, has sold at a sharp discount since the collapse of the Berlin Wall, it continues to thrive on Wall Street."  

Grant might add:  This support of central economic planning thrives among the editorial board of the Wall Street Journal, despite its generally unapologetic free market predilections.

Second, the Fed says that its major goal policy goal is the maintenance of price stability.  By manipulating the federal funds rate, the Fed acts ostensibly to impede price indices from rising or falling.  Any perceived deflationary forces affecting the price level are met with expansionary policies, while any perceived inflationary tendencies are met with contractionary policies.  

Apart from the aggregation problems that accompany the construction of price indices, a serious problem with this practice is that it stands athwart the general tendency for prices to fall over time.  In fact, one of the benefits of competitive markets is that products that only the rich can afford in one generation frequently become mass marketed to the following generation.  Thanks to economies of scale, the poor in the U.S. can take for granted consumer products that were considered luxury items a half a century ago.  Yet, in the name of price stability, there are policies in place that obstruct this natural tendency.  

It doesn’t help matters that the Fed is a failure at this goal in the first place.  According to the government’s own statistics, a dollar printed in the year 2000 is worth two-thirds of the value of the dollar printed in 1987, the year Alan Greenspan was first nominated to the Fed chairmanship.  For this fact alone, the Fed chairman deserved to be dethroned long before the current slowdown in economic activity.  (In fairness, so do members of Congress who increase spending to record levels with the passage of each new budget.)

It stands to reason that, with so much intervention in the economy with the intent (for instance) to stabilize the business cycle, maintain stock prices, or reduce bond yields, all while trying to appease the political class, economic downturns are inevitable.  It truly would require a "master of the universe" to accomplish such a feat.  The problem is the central banking system itself, circa 2001, with its dangerous mixture of fiat currencies and political business cycles.   

That such a mixture produces bad results is no mystery, and it is disingenuous to lump them together with other mysteries, such as Stonehenge, UFOs, and the continued acceptance of the Keynesian paradigm.  Indeed, it is intellectually dishonest, because it allows mainstream economists (and economic journalists) to avoid responsibility for policy prescriptions that cause economic downturns.

The Austrian School, however, has long understood the causes of recessions, dating at least to the publication of Ludwig von Mises’ The Theory of Money and Credit.  It calls for the abolishment of fiat currencies that allow politicians to finance spending through increases in prices, and return the monetary system of a gold standard.  

The role of the central banker in such a system is not as glamorous.  The economy’s currency would manage itself in relationship to the gold supply, a task that could be accomplished without the Fed’s current 25,000 employees.  History shows that such a system resulted in stable and gently falling price levels coupled with low unemployment.  What’s more, the gold standard was sufficient for an industrial revolution or two.

Unfortunately, such solutions are given short shrift by mainstream economic thinkers because far-reaching reform would remove any important role to Fed policy makers, presidential and congressional economic advisors, and Wall Street Journal editors.  Robert Bartley probably knows better. Gold’s track record is much better than the Federal Reserve’s.

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Christopher Westley, adjunct scholar of the Mises Institute, is an assistant professor of economics at Jacksonville State University. Send him mail and see his Daily Article Archive. See also the Austrian Study Guide for articles on the business cycle, as well as The Austrian Theory of the Trade Cycle and Other Essays. Joe Salerno's history of recent Fed behavior should not be missed.  Finally, read an interview with James Grant in the AEN.