(The first installment of “The Keynesian Myth” is here.)
All-American Money Makers
Although conventional wisdom has it that Keynes considered government spending far more capable of ending the depression than monetary expansion, that certainly wasn’t his view in 1931: during lectures he gave then at the University of Chicago, he disappointed faculty members who themselves favored more spending on public works over monetary easing by expressing the opposite opinion.
Nor had Keynes lost faith in monetary policy in March 1933, when he published a series of articles in the London Times, later republished as a pamphlet called The Means to Prosperity. In the second installment of that series, on “The Raising of Prices,” Keynes argued that boosting the public’s “aggregate spending power” called for aggressive “open-market operations to make bank credit cheap and abundant.” He then went on to accuse the Fed of having “bungled” by failing to load up on securities while it was still flush with gold.
As I showed elsewhere in this series, after Roosevelt took office the Fed kept right on bungling. Although the Thomas amendment authorized him to compel the Fed banks to buy up to $3 billion worth of government securities, he never took advantage of that authority.[1] Nor did his dismantlement of the gold standard make much difference: despite it, the Fed’s combined holdings of bills and securities remained virtually flat throughout the New Deal.
It is, nevertheless, misleading to suggest that the Fed bungled because no one there or in the administration took Keynes’s advice. As David Laidler (1999, p. 183) (among others) has observed, by the early 1930s, America had plenty of home-grown champions of expansionary monetary policy, with “vigorous and diverse” writings supporting their arguments. The government’s failure to take this American advice was far more blameworthy than its failure to heed that of a still far from famous British economist.
American economists had already started calling for a more expansionary monetary policy while Hoover was president. Fisher had long favored a dollar managed so as to keep the general price level stable. Having long tried, and failed, to get the government to adopt his “compensated dollar” plan, by 1928, when he published The Money Illusion, Fisher had instead come to regard stabilizing the price level, through discretionary open market operations and rediscount rate changes, as the Fed’s duty. Come 1932, in Booms and Depressions, he was blaming the depression on the decline in the dollar’s purchasing power, and calling for the Fed to “reflate” prices to their pre-depression level.
Earlier that same year, in a January, 1932 memo to Hoover, three young Harvard economists urged Hoover to support both aggressive Fed open market operations and more spending on public works. Nor were the three—Lauchlin Currie, Theodore Ellsworth, and Harry Dexter White—the only ones to do so. Their plea was soon echoed by 24 other economists, including a dozen from the University of Chicago. In short, as Laidler (n.d., p. 12) puts it, “contrary to later myths surrounding the so-called ‘Keynesian Revolution,’ support for vigorous open market operations was no novelty in the early 1930s.”
Novelty or not, so far as the Hoover administration was concerned, the American economists’ advice fell on deaf ears. The Roosevelt administration, on the other hand, looked likely to give them a hearing when Morgenthau, upon becoming Treasury Secretary in January 1934, invited one of them—the University of Chicago’s Jacob Viner—to form a “Freshman Brain Trust” to advise the government on monetary and fiscal policy. Viner in turn asked both Currie and White to join that group. It was while serving in the Freshman Brain Trust that Currie published The Supply and Control of Money in the United States, which, among other things, documented how the Fed’s failure to undertake open-market purchases large enough to keep the money stock from collapsing contributed to what Milton Friedman and Anna Schwartz, in their later and more famous account, christened the “Great Contraction.” Currie thus holds the unusual distinction of having been a forerunner of both the most celebrated Keynesian and his most famous critic!
Any of several events that followed Currie and White’s arrival at the Treasury might also have been expected to bring about a shift toward unstinting monetary expansion. First came the official denouement of FDR’s gold policy in February. Then came Marriner Eccles’ appointment, at Morgenthau’s suggestion, as Fed governor that fall, with Currie in tow as his chief advisor. Finally, there was the August, 1935, Banking Act that Eccles helped shape, transferring responsibility for setting discount rates and conducting open-market operations from the reserve banks to the newly-established Board of Governors.
Freed from the old gold standard constraint, and equipped with more discretionary power over monetary policy than any Fed governor ever was, the Fed’s first chairman was certainly in a position to up the Fed’s game: besides bringing Currie with him from the Treasury, Eccles himself had long supported what we now think of as “Keynesian” policies for combating the depression, though he, like Currie, came to his beliefs with no help at all from Keynes. “The concepts I formulated,” Eccles says in his 1951 memoir, “were not abstracted from [Keynes’s] books, which I have never read.” When, several decades later, Milton Friedman opined that Eccles “played a far greater role in the development of what later came to be called Keynesian policies than did Keynes or any of his disciples” (Israelsen 1985, p. 362), he was only saying what most historians of American macroeconomic thought now recognize.
But for Eccles, expansionary fiscal policy was the real key to restoring full employment. “Financial fuel,” he once wrote, isn’t enough; “[t]he Government…must apply the torch” (ibid., p. 360). The task of monetary policy, as Eccles understood it, was to underwrite expansionary fiscal policy, keeping interest rates low, so the Treasury could borrow cheaply. Because interest rates were in fact low throughout the depression, this understanding was perfectly consistent with the Fed’s continuing to play a passive role. The major exception to that stance—what Charles Calomiris and David Wheelock consider the Fed’s “first major policy initiative after 1933”—was the Fed’s controversial decision to double member banks’ reserve requirements during 1936 and 1937, a step Eccles and Currie both supported and later defended, but one that was far more likely to prove contractionary than expansionary. One wonders what Keynes thought of it. But so far as I’m able to discover, he never said.
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