Macroeconomic Booms and Busts: Deja Vu Once Again

Consider the following commentary on the economic situation:

Foolhardy procedures which are divorced from economic realities, or whose economic implications are not understood by their promoters, do not perforce become sanctified and wise merely by designating them as “action”; tilting at windmills does not draw water.

[W]hen a recovery program, which, while it may appear effective, depends for its efficacy upon much the same kind of “cheap money” inflation which . . . was the main cause of the recession from 2007 to 2009, then the present recovery must ultimately prove as illusory as the boom from 2001 to 2007, and it is the duty of economists to pierce the veil of illusion.

Certainly the recovery movement to the date of this writing [December 2010] is a peculiar one: it is shot through with anomalies. With [more than 15 million estimated to be] unemployed . . . with governmental relief rolls still at high levels, . . . there very obviously is something wrong, somewhere.

The fact would seem to be that the authorities who are undertaking the “management” of the current recovery, and congratulating themselves that prosperity is returning because they “planned it so,” are utterly oblivious of the fact that recovery is being engineered largely by the same means which produced the last boom – and recession. With this difference: whereas the banking system during the recent boom was producing an investment credit inflation by extending credit to business men and corporations, Government is now assuming the role of inducing new deposit currency in the banking system and thereby producing a consumption credit inflation. The Federal Government, instead of private corporations, is issuing the bonds which the banks are now purchasing, thereby inflating the deposit currency structure all over again. These “created” funds are in this instance being used principally to finance consumption expenditures through relief disbursements, make-work projects, and the like. . . . [T]he current inflation tends to conceal and to preserve the fundamental disequilibria which so prolonged the recession after 2007 and which we are now carrying over therefrom without having once squarely faced the problem of correcting them.

Notice, however, that the foregoing commentary, except for the terms in bold font, was written not yesterday, but, in its final form, in 1937. The authors, C. A. Phillips, T. F. McManus, and R. W. Nelson, placed this commentary, along with a wealth of related evidence and analysis, in their unjustly neglected book Banking and the Business Cycle: A Study of the Great Depression in the United States (New York: Macmillan, 1937). The quoted passages, which appear on pp. 212-14, originally read as follows:

Foolhardy procedures which are divorced from economic realities, or whose economic implications are not understood by their promoters, do not perforce become sanctified and wise merely by designating them as “action”; tilting at windmills does not draw water.

[W]hen a recovery program, which, while it may appear effective, depends for its efficacy upon much the same kind of “cheap money” inflation which . . . was the main cause of the Great Depression, then the present recovery must ultimately prove as illusory as the New Era of the ‘twenties; and it is the duty of economists to pierce the veil of illusion.

Certainly the recovery movement to the date of this writing [February 1937] is a peculiar one: it is shot through with anomalies. With [8 million to 12 million estimated to be] unemployed . . . with governmental relief rolls still at high levels, . . . there very obviously is something wrong, somewhere.

The fact would seem to be that the authorities who are undertaking the “management” of the current recovery, and congratulating themselves that prosperity is returning because they “planned it so,” are utterly oblivious of the fact that recovery is being engineered largely by the same means which produced the last boom—and depression. With this difference: whereas the banking system during the ‘twenties was producing an investment credit inflation by extending credit to business men and corporations, Government is now assuming the role of inducing new deposit currency in the banking system and thereby producing a consumption credit inflation. The Federal Government, instead of private corporations, is issuing the bonds which the banks are now purchasing, thereby inflating the deposit currency structure all over again. These “created” funds are in this instance being used principally to finance consumption expenditures through relief disbursements, make-work projects, and the like. . . . [T]he current inflation tends to conceal and to preserve the fundamental disequilibria which so prolonged the Great Depression and which we are now carrying over therefrom without having once squarely faced the problem of correcting them.

When policy makers repeat in the early twenty-first century the same mistakes they made in the 1920s and 1930s, and when mainstream economists fail to understand that these policies are misguided now, just as they were then, one can scarcely argue that the mainstream understanding of business fluctuations has advanced at all during the past eighty years. Indeed, the typical macroeconomist today is much inferior to Phillips, McManus, and Nelson, in no small part because today’s economists, owing to the high level of aggregation they employ in their theoretical and empirical work, miss what is most important for understanding business booms and busts: policy-induced structural disequilibria and malinvestments.