Back to a mixed economy

Economist Brad DeLong gives a short intellectual history of economic paradigms in the United States. In the nineteenth and early twentieth century there were the laissez-faire economists. With the arrival of the Great Depression and World War II in the thirties, however, it became quite evident that the government needed to participate more vigorously in managing the economy. John Maynard Keynes brought a dose of reasonableness to the field with his theory of a “mixed economy” in which governments dampen recessions and increase levels of employment through fiscal policy.
Beginning in the seventies, however, laissez-faire principles had their revenge with Milton Friedman.
Friedman proposed that with one minor, technocratic adjustment a largely unregulated free-market would work just fine. That adjustment? The government had to control the “money supply” and keep it growing at a steady, constant rate-no matter what. Since money was what people used to pay for their spending, a smoothly-growing money supply meant a smoothly-growing flow of spending and, hence, no depressions…
However, as we are seeing today, keeping the money supply growing is not entirely under governments’ control. Adjusting interest rates and regulating the printing of money is not enough.
When banks and businesses and households get scared and cautious and feel poor, they take steps to shrink the economic reality that is the “money supply.” Businesses extend less trade credit. Credit card companies cut off cards and reduce ceilings. Banks call in loans and then take no steps to replace the deposits extinguished by the loan pay-downs. Without a single bureaucrat making a single decision to slow down a single printing press, the money supply shrinks—disastrously in episodes like the Great Depression. Thus in emergencies, to say that all the central bank has to do is to keep the money supply growing smoothly is very like saying that all the captain of the Titanic has to do is to keep the deck of the ship level.
It was not possible to ward off the current recession by adjusting interest rates and printing more money.
So increasingly over the past year, the central ministries of the globe have taken extra measures: they have guaranteed debts, they have partially or completely nationalized banks, they have forced weak institutions to merge with stronger ones, they have expanded their balance sheets to an extraordinary extent. And yet this, too, has not been enough.
There is nothing else to do than to return to a more reasonable “mixed market” approach. Monetary policy must be combined with strong fiscal policy.
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