Crisis Economics – A history and what now

“I guess everyone’s a Keynesian in the foxhole.” – Robert Lucas, University of Chicago, 2008

From Getty Images – Red fox (Vulpes vulpes) peeking out from hole in log, captive, North America, autumn

Since its founding the U.S. government has generally adopted a hands-off attitude with private business.  During the Gilded Age of the late 1800s the economy was so wild economic historian, John Steel Gordon, labeled it, “Capitalism Red in Tooth and Claw.”  Alan Greenspan’s claimed the U.S. was “the world’s most laissez faire” country during this period. 

While there were some reforms in the Progressive Era (1900-1920) , they did not address the banking and finance industry.  In the 1920s banks and brokerage houses fueled the roaring 1920s era of runaway speculation.  Excess leverage pushed up the prices of nearly everything until it came crashing down in the Great Depression.  As deflation spread industries went bankrupt, banks failed by the thousands and unemployment skyrocketed to a quarter of the U.S. working population.  The unsteady nature of President Hoover’s efforts did little to stem the growing tide of job losses and widespread hunger.   

Against this tide of woe, a tsunami of confidence swept into the White House with the election of Franklin Delano Roosevelt (FDR).  He applied the theories of economist John Maynard Keynes to combat the Great Depression.  Keynes favored lower interest rates and increased spending by the federal government to offset declines in business and consumer spending. 

From 1933 to 1937 FDR implemented a “Keynesian” stimulus as part of the New Deal.   U.S. production increased by an average of nearly 10 percent a year while unemployment shrank from 24 percent to 14 percent.  In late 1937 Roosevelt reversed the Keynesian stimulus and much of the economic progress was lost.

Conservative economic historians and free market fundamentalists ignore or confuse the success of the Keynesian stimulus.  Nonetheless, the results were clear.  When the economy was depressed, the fiscal and monetary stimulus helped it recover; when the stimulus was reversed, the recovery stalled.    

By the mid-1970s Keynesian ideas fell out of favor as inflation lingered and the stock market stagnated.  Opposition to the New Deal was bred at the University of Chicago school of economics.  The rise of the Chicago school was a reaction to, and rejection of, Keynes.  In the 1980s University of Chicago economics Professor Robert Lucas declared Keynes’ economic theories dead and explained, “At research seminars, people don’t take Keynesian theorizing seriously anymore; the audience starts to whisper and giggle to one another.”     

U.S. economic policy returned to the old hands-off approach supported by advocates of neoliberalism, supply side economics and free market fundamentalism.  Neoliberal economics preaches lower taxes for those with high incomes, less regulation for industry and private sector domination of the economy.

In good times these polices facilitated the building of colossal personal fortunes.  They also fueled the fire of economic disruptions for which the policies provided no response other than to wait and, possibly, lower interest rates.  

Modern political economies demand effective responses to economic crises.  Economist John Maynard Keynes explained, “In the long run we are all dead.  Economists set themselves too easy, too useless a task, if in tempestuous seasons they can only tell us, that when the storm is long past, the ocean is flat again.” 

In 1982 the savings and loan (S&L) industry was deregulated and the institutions entered into new and unregulated fields.  By 1985 there was only $4 billion in the insurance fund to cover $20 billion of losses among the S&Ls and by 1987 the fund itself was insolvent.  Neither supply side economics nor neoliberalism offered an answer to this dilemma. 

Neoliberal policies have proved as effective in creating crises as they are ineffective in combating them.  The S&L bailout eventually cost taxpayers $132 billion.

In the 1990s and 2000s the far larger commercial and investment banks were deregulated.  Speculation and leverage based on the housing market ran amok until financial institutions and funds around the globe became insolvent.  By 2008 the global gears of commerce ground to a halt.  

The U.S. economy lost three and a half million jobs between November 2008 and March 2009, and more than eight million by the end of recession.  The U.S. economy shrank by more than 4 percent between the end of 2007 and 2009 and lost more than $13 trillion in wealth.    

In 2008, Chicago Professor Lucas conceded, “I guess everyone’s a Keynesian in the foxhole.”

The Emergency Economic Stabilization Act of 2008 authorized $700 billion to rescue the financial industry, the automotive industry and families facing foreclosure.  The federal reserve bought worthless assets from the surviving banks and in 2009 Congress appropriated nearly $800 billion in stimulus spending to restart the economy.  These expenditures stabilized the economy and put it back on a growth trajectory which continued until the outbreak of the corona virus.

This month, once again, the country found itself in a foxhole.  The corona virus (COVID-19) led to the loss of 3 million jobs in a week and widespread socioeconomic disruption.  Neoliberalism, supply side theories and conservative economics have provided no answers, other than waiting.  Washington again turned to a Keynesian stimulus to revive the economy. 

Economists will point out that the current recession caused by the corona virus is an “exogenous” (or, outside) event which was not generated by the malfunctioning of the market itself, unlike the Great Depression, the S&L meltdown and the Great Recession.  While this is true it, is also true that neoliberalism offers no answers for exogenous or endogenous (inside the economy) shocks.  Moreover, as each successive disruption proves, it less likely to be the last.

A strong case can be made for economic policies which discourage destabilizing speculation, provide remedies for economic disruptions and soften the blow for the most vulnerable workers.  Humanity aside, it’s probably a hell of a lot cheaper.  

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