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NOTE 28. The Keynesian Policies

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Chapter 28 The Keynesian Policies

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Do Deficits Cure Unemployment?

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In our chapter-by-chapter analysis of Keynesian theory, we have had occasion to examine in passing the implied Keynesian policies and their probable consequences.

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But it may now be useful to discuss some of these main policies more explicitly.

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In Keynesian policy, unemployment is never to be corrected by any reduction of money

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wage rates.

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Keynes recommends two main remedies.

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One is deficit spending, sometimes euphemistically called government investment.

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How good is this remedy?

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It was tried in the United States, partly because of Keynes's recommendations, for a full decade.

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What were the results?

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Here are the deficit in the federal budget, the number of unemployed, and the percentage

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of unemployed to the total labor force, year by year, in that decade.

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All the figures are from official sources.

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In the year 1931, the deficit was $0.5 billion, unemployed were 8 million people, percentage

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of unemployed was 15.9%.

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In the year 1932, the deficit was $2.7 billion, the unemployed were 12.1 million people, and

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the percentage of unemployed was 23.6%.

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In the year 1933, the deficit was $2.6 billion, the unemployed were 12.8 million people, and

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And the percentage of unemployed was 24.9%.

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In the year 1934, the deficit was $3.6 billion, the unemployed were 11.3 million people, and

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the percentage of unemployed was 21.7%.

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In the year 1935, the deficit was $2.8 billion.

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The unemployed were 10.6 million people.

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And the percentage of unemployed was 20.1%.

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In the year 1936, the deficit was $4.4 billion.

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The unemployed were 9 million people, and the percentage of unemployment was 16.9%.

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In the year 1937, the deficit was $2.8 billion, the unemployed were 7.7 million people, and

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the percentage of unemployment was 14.3%.

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In the year 1938, the deficit was $1.2 billion, the unemployed were 10.4 million people, and

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the percentage of unemployment was 19%.

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In the year 1939, the deficit was $3.9 billion, the unemployed were 9.5 million people, and

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and the percentage of unemployment was 17.2%.

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In the year 1940, the deficit was $9.3 billion, the unemployed were 8.1 million people, and

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the percentage of unemployment was 14.6%.

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In the foregoing table, the deficits are for fiscal years ending on June 30th.

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The unemployment is an average for the full calendar year.

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The deficit figures, therefore, lead the unemployment figures by six months.

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Advocates of deficit spending, no doubt, will try to find a partial negative correlation

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between the size of the deficit and the subsequent number of unemployed.

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But the central and decisive fact is that heavy deficits were accompanied by mass unemployment.

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The average unemployment of the 10-year period was 9.9 millions, which was 18.6% of the total

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working force.

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The average deficit in this 10-year period was $2.8 billion, which was 3.6% of the gross

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national product of the period.

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The same percentage of the gross national product of 1957 would mean an annual deficit

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of $15.6 billion.

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Does Cheap Money Cure Unemployment?

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The other main Keynesian remedy for unemployment is low interest rates, artificially produced

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by the monetary authority.

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Keynes incidentally admits, e.g. page 205, that such artificially low interest rates can

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can only be produced by printing more money, i.e. by deliberate inflation.

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But we may let this pass for the moment.

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The question immediately before us is, do low interest rates prevent mass unemployment?

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The policy of cheap money has had an even longer trial than the policy of planned deficits.

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Let us look at the record of interest rates and unemployment for the same period that

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we have just reviewed, adding, however, 1929 and 1930.

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In the table below, the first column after that of the years represents the average rate

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in each year, the average daily prevailing rates of prime commercial paper with a maturity

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of Four to Six Months.

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I have chosen this rate rather than that on three-month Treasury bills because it is the

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most available statistical series reflecting the short-term interest rates at which business

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actually borrows.

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Actually, the greatest volume of business borrowing from banks in the U.S. consists

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of Line of Credit Loans, but these vary with the more sensitive commercial paper rate.

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The final column once again gives the percentage of unemployed to the total labor force.

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Both sets of figures are from official sources.

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In the year 1929, the commercial paper rate was 5.85%.

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The Percentage of Unemployment 3.2% In the year 1930, the commercial paper rate

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was 3.59%.

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The percentage of unemployment 8.7%.

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In the year 1931, the commercial paper rate was 2.64%.

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The percentage of unemployment 15.9%.

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In the year 1932, the commercial paper rate was 2.73%.

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The percentage of unemployment, 23.6%.

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In the year 1933, the commercial paper rate was 1.73%.

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The percentage of unemployment, 24.9%.

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In the year 1934, the commercial paper rate was 1.02%.

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The percentage of unemployment, 21.7%.

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In the year 1935, the commercial paper rate was 0.75%.

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The percentage of unemployment, 20.1%.

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In the year 1936, the commercial paper rate was .75%, the percentage of unemployment 16.9%.

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In the year 1937, the commercial paper rate was .94%, the percentage of unemployment 14.3%.

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In the year 1938, the commercial paper rate was .81%, the percentage of unemployment 19%.

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In the year 1939, the commercial paper rate was .59%, the percentage of unemployment 17.2%.

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In the year 1940, the commercial paper rate was .56%, the percentage of unemployment 14.6%.

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In sum, over this period of a dozen years, low interest rates did not eliminate unemployment.

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On the contrary, unemployment actually increased as interest rates went down.

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In the seven-year period from 1934 through 1940, when the cheap money policy was pushed

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to an average infra-low rate below 1%, .77 of 1%, an average of more than 17 in every

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100 persons in the labor force were unemployed.

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Let us skip over the war years when war demands massive deficits and massive inflation come

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Combined to bring over-employment and take up the record again for the last ten years.

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In the year 1949, the commercial paper rate was 1.49%.

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The percentage of unemployment, 5.5%.

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In the year 1950, the commercial paper rate was 1.45%.

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The percentage of unemployment, 5%.

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In the year 1951, the commercial paper rate was 2.16%.

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The percentage of unemployment, 3%.

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In the year 1952, the commercial paper rate was 2.33%.

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The percentage of unemployment, 2.7%.

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In the year 1953, the commercial paper rate was 2.52%.

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The percentage of unemployment, 2.5%.

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In the year 1954, the commercial paper rate was 1.58%.

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The percentage of unemployment, 5%.

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In the year 1955, the commercial paper rate was 2.18%.

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The percentage of unemployment, 4%.

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In the year 1956, the commercial paper rate was 3.31%.

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The percentage of unemployment, 3.8%.

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In the year 1957, the commercial paper rate was 3.81%.

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The percentage of unemployment, 4.3%.

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In the year 1958, as of June, the commercial paper rate was 1.54%.

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The percentage of unemployment, 6.8%.

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Unemployment percentages before 1957 are based on Department of Commerce old definitions

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of unemployment.

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For 1957 and 1958, they are based on the new definitions, which make unemployment slightly

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higher, 4.2% of the labor force in 1956, for example, instead of the 3.8% in the table.

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It will be noticed in this table that though the commercial paper interest rate in this

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period averaged 2.24% or three times as high as that in the seven years from 1934-1940,

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the rate of unemployment was not higher but much lower, averaging only 4.2% compared with

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with 17.7% in the 1934 through 1940 period.

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And within this second period itself, the relationship of unemployment to interest rates

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is almost the exact opposite of that suggested by Keynesian theory.

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In 1949, 1950, 1954 and June of 1958, when the commercial paper interest rate averaged

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about 1.5%, unemployment averaged 5% and over.

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In 1956 and 1957, when commercial paper rates were at their highest average level of the

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It is very difficult, if not impossible, to prove a positive proposition in economic theory

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by the use of statistics, but it is not difficult to disprove such a proposition unless it is

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elaborately qualified by statistics.

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We must conclude at least that neither deficit spending nor cheap money policies are enough

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by themselves to eliminate even prolonged mass unemployment, let alone to prevent unemployment

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altogether.

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Race with the Printing Press

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But these are the chief Keynesian remedies for unemployment.

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In 1936, reviewing the general theory, which had appeared in the same year, Professor Jacob

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Weiner ventured a prediction.

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Keynes's reasoning points obviously to the superiority of inflationary remedies for unemployment

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over money-wage reductions.

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In a world organized in accordance with Keynes's specifications, there would be a constant

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race between the printing press and the business agents of the trade unions, with the problem

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of unemployment largely solved if the printing press could maintain a constant lead, and

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if only volume of employment, irrespective of quality, is considered important.

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This characterization has proved, in part, remarkably prophetic.

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There may be some doubt whether the problem of unemployment has been largely solved.

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But we have certainly been trying to solve it since 1936 in accordance with Keynes's

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specifications, and we have certainly embarked upon a race between the printing press and

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and the Trade Unions.

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And our failure to solve the problem of unemployment, even by this method, is partly the result

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of a development Professor Weiner could hardly have been expected to foresee.

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The spread of escalator clauses in labor contracts, which provide not only for automatic increases

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with every increase in the cost of living, but for so-called productivity increases which

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come into effect whether marginal labor productivity actually increases or not.

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The truth is that the only real cure for unemployment is precisely the one that Keynes's whole general

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theory was designed to reject.

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The Adjustment of Wage Rates to the Marginal Labor Productivity or Equilibrium Level.

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This does not mean a uniform and block adjustment of the wage level to the price level.

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It means the mutual adjustment of specific wage rates and of prices of the specific products

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various groups of workers help to produce.

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It means also the adjustment of various wage rates to each other, and of various prices

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to each other.

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It means the coordination of the complex wage-price structure.

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It means the maintenance of a free, fluid, dynamic equilibrium, or a constant tendency

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towards such an equilibrium through the economic system.

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In sum, neither government spending nor low interest rates nor an increase in the money

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supply is either a necessary or a sufficient condition for the existence of full employment.

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What is necessary for full employment, using the word in a working, practical sense, is

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a proper relation among the prices of different kinds of goods and a proper balance between

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between costs and prices, particularly between wages and prices.

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This functional balance will tend to exist when wage rates are free and fluid and competitive,

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and not dictated by arbitrary union coercion.

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When this balance exists, full employment and maximized production and prosperity will

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tend to follow.

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When this balance does not exist, when wage rates are pushed above the marginal product

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of labor and profit margins are doubtful or disappear, there will be unemployment.

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The presence or absence of monetary inflation, in brief, is by itself irrelevant to full

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employment.

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All that government policy needs to do, besides keeping the currency sound, is to enforce

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the laws against violence and intimidation, and to repeal the laws which confer exclusive

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legal privileges and immunities on union leaders, or abridge the freedom of employers and individual

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workers to bargain.

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As Professor Sylvester Petro has put it, the legal reforms needed may all be subsumed under

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a single heading, unqualified supremacy of the principle of free employee choice.