The Inflation Crisis, and How to Resolve It

18

How Cheap Money Fails

John Maynard Keynes preached two great remedies for unemployment. One was deficit financing. The other was artificially cheap money brought about by central bank policy. Both alleged remedies have since been assiduously pursued by nearly all governments. The result has been worldwide inflation and a constantly shrinking purchasing power of monetary units. But the success in curing unemployment has been much more doubtful. In an earlier chapter we considered the unpromising results of budget deficits. Does cheap money have any better record?

The following table covers the twelve years 1929–40, comparing the average annual rate of prime commercial paper maturing in four to six months with the percentage of unemployment in the same year. Both sets of figures are from official sources.

In sum, over this period of a dozen years low interest rates did not eliminate unemployment. On the contrary, unemployment actually increased in years when interest rates went down. Even in the seven-year period from 1934 through 1940, when the cheap-money policy was pushed to an average infralow rate below one percent (0.77 of one percent), an average of more than seventeen in every hundred persons in the labor force were unemployed.

Let up skip over the war years when war demands, massive deficits, and massive inflation combined to bring overemployment, and take up the record again for the eleven years 1949–59.

The following table shows that, although the commercial paper interest rate in this period averaged 2.48 percent—more than three times as high as that in the seven years from 1934 through 1940—the rate of unemployment was not higher, but much lower, averaging only 4.4 percent compared with 17.7 percent in the 1934–40 period.

Within this second period, the relationship of unemployment to interest rates is almost the exact opposite of that suggested by Keynesian theory. In 1949, 1950, and 1954, when the commercial paper interest rate averaged about 1.5 percent, unemployment averaged 5 percent and more. In 1956, 1957, and 1959, when commercial paper rates were at their highest average level of the period at 3.70 percent, unemployment averaged only 4.4 percent of the working force.

We come to the next ten-year segment, 1960 through 1969:

In the ten-year period 1960–69 interest rates were edging up. They averaged 4.64 percent a year, compared with 2.48 percent a year in the 1949–59 period—an increase of 87 percent. Yet the average unemployment rate advanced from 4.4 to only 4.8 percent, or less than 10 percent. And in 1969 itself, when the commercial paper rate was the highest of any year in the period, the unemployment rate was also the lowest for any year in the period.

Now we come to the final seven years:

Here at last, on the overall figures of these seven years, we seem to find some statistical support for the thesis that high interest rates breed higher unemployment. The average annual commercial paper rate for the period jumped to 6.74 percent, and the average annual unemployment rate also rose—to 6.2 percent. But the briefest analysis shows that even this slight appearance of statistical support is illusory. For if out of this seven years we take the three years—1970, 1973, and 1974—in which interest rates were above the average for the period, we find that the average unemployment rate for those three years was only 5.13 percent, or below the average for the full period. In the other four years, when interest rates were lower than the average for the full period, the average unemployment rate was 6.92 percent—higher than for the full period. (In 1977, not shown on the table, the commercial paper rate rose to 5.60 percent, but the unemployment rate fell to 7.0 percent.)

But there may well be an apparent correspondence between higher interest rates and higher unemployment in the future, on the assumption that the present inflation continues or accelerates. The reason is that in the late stages of an inflation interest rates finally begin to catch up with money-depreciation rates, and in the late stages of an inflation, also, the increasing uncertainty and price-cost discoordination breeds increasing unemployment.

In sum, neither deficit spending nor cheap-money policies are enough by themselves to eliminate even prolongued mass unemployment, let alone to prevent unemployment altogether.

The only real cure for unemployment is precisely the one that the Keynsians and inflationists reject—the adjustment of wage rates to the marginal labor productivity, or “equilibrium,” level—the balance and coordination of wages and prices. When individual wage rates are in equilibrium with individual prices, there will tend to be full employment regardless of whether interest rates are “high” or “low.” But regardless of how low interest rates are pushed, there will be unemployment where wage rates are too high to permit workable profit margins.

2 Unemployment percentages before 1957 are based on Department of Commerce “old definitions” of unemployment; for 1957 and after they are based on the “new definitions,” which make unemployment slightly higher—4.2 percent of the labor force in 1956, for example, instead of the 3.8 percent in the table.

• 1+   269*
• 2* Surplus.