Chapter 28 The Keynesian Policies
Do Deficits Cure Unemployment?
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.
But it may now be useful to discuss some of these main policies more explicitly.
In Keynesian policy, unemployment is never to be corrected by any reduction of money
wage rates.
Keynes recommends two main remedies.
One is deficit spending, sometimes euphemistically called government investment.
How good is this remedy?
It was tried in the United States, partly because of Keynes's recommendations, for a full decade.
What were the results?
Here are the deficit in the federal budget, the number of unemployed, and the percentage
of unemployed to the total labor force, year by year, in that decade.
All the figures are from official sources.
In the year 1931, the deficit was $0.5 billion, unemployed were 8 million people, percentage
of unemployed was 15.9%.
In the year 1932, the deficit was $2.7 billion, the unemployed were 12.1 million people, and
the percentage of unemployed was 23.6%.
In the year 1933, the deficit was $2.6 billion, the unemployed were 12.8 million people, and
And the percentage of unemployed was 24.9%.
In the year 1934, the deficit was $3.6 billion, the unemployed were 11.3 million people, and
the percentage of unemployed was 21.7%.
In the year 1935, the deficit was $2.8 billion.
The unemployed were 10.6 million people.
And the percentage of unemployed was 20.1%.
In the year 1936, the deficit was $4.4 billion.
The unemployed were 9 million people, and the percentage of unemployment was 16.9%.
In the year 1937, the deficit was $2.8 billion, the unemployed were 7.7 million people, and
the percentage of unemployment was 14.3%.
In the year 1938, the deficit was $1.2 billion, the unemployed were 10.4 million people, and
the percentage of unemployment was 19%.
In the year 1939, the deficit was $3.9 billion, the unemployed were 9.5 million people, and
and the percentage of unemployment was 17.2%.
In the year 1940, the deficit was $9.3 billion, the unemployed were 8.1 million people, and
the percentage of unemployment was 14.6%.
In the foregoing table, the deficits are for fiscal years ending on June 30th.
The unemployment is an average for the full calendar year.
The deficit figures, therefore, lead the unemployment figures by six months.
Advocates of deficit spending, no doubt, will try to find a partial negative correlation
between the size of the deficit and the subsequent number of unemployed.
But the central and decisive fact is that heavy deficits were accompanied by mass unemployment.
The average unemployment of the 10-year period was 9.9 millions, which was 18.6% of the total
working force.
The average deficit in this 10-year period was $2.8 billion, which was 3.6% of the gross
national product of the period.
The same percentage of the gross national product of 1957 would mean an annual deficit
of $15.6 billion.
Does Cheap Money Cure Unemployment?
The other main Keynesian remedy for unemployment is low interest rates, artificially produced
by the monetary authority.
Keynes incidentally admits, e.g. page 205, that such artificially low interest rates can
can only be produced by printing more money, i.e. by deliberate inflation.
But we may let this pass for the moment.
The question immediately before us is, do low interest rates prevent mass unemployment?
The policy of cheap money has had an even longer trial than the policy of planned deficits.
Let us look at the record of interest rates and unemployment for the same period that
we have just reviewed, adding, however, 1929 and 1930.
In the table below, the first column after that of the years represents the average rate
in each year, the average daily prevailing rates of prime commercial paper with a maturity
of Four to Six Months.
I have chosen this rate rather than that on three-month Treasury bills because it is the
most available statistical series reflecting the short-term interest rates at which business
actually borrows.
Actually, the greatest volume of business borrowing from banks in the U.S. consists
of Line of Credit Loans, but these vary with the more sensitive commercial paper rate.
The final column once again gives the percentage of unemployed to the total labor force.
Both sets of figures are from official sources.
In the year 1929, the commercial paper rate was 5.85%.
The Percentage of Unemployment 3.2% In the year 1930, the commercial paper rate
was 3.59%.
The percentage of unemployment 8.7%.
In the year 1931, the commercial paper rate was 2.64%.
The percentage of unemployment 15.9%.
In the year 1932, the commercial paper rate was 2.73%.
The percentage of unemployment, 23.6%.
In the year 1933, the commercial paper rate was 1.73%.
The percentage of unemployment, 24.9%.
In the year 1934, the commercial paper rate was 1.02%.
The percentage of unemployment, 21.7%.
In the year 1935, the commercial paper rate was 0.75%.
The percentage of unemployment, 20.1%.
In the year 1936, the commercial paper rate was .75%, the percentage of unemployment 16.9%.
In the year 1937, the commercial paper rate was .94%, the percentage of unemployment 14.3%.
In the year 1938, the commercial paper rate was .81%, the percentage of unemployment 19%.
In the year 1939, the commercial paper rate was .59%, the percentage of unemployment 17.2%.
In the year 1940, the commercial paper rate was .56%, the percentage of unemployment 14.6%.
In sum, over this period of a dozen years, low interest rates did not eliminate unemployment.
On the contrary, unemployment actually increased as interest rates went down.
In the seven-year period from 1934 through 1940, when the cheap money policy was pushed
to an average infra-low rate below 1%, .77 of 1%, an average of more than 17 in every
100 persons in the labor force were unemployed.
Let us skip over the war years when war demands massive deficits and massive inflation come
Combined to bring over-employment and take up the record again for the last ten years.
In the year 1949, the commercial paper rate was 1.49%.
The percentage of unemployment, 5.5%.
In the year 1950, the commercial paper rate was 1.45%.
The percentage of unemployment, 5%.
In the year 1951, the commercial paper rate was 2.16%.
The percentage of unemployment, 3%.
In the year 1952, the commercial paper rate was 2.33%.
The percentage of unemployment, 2.7%.
In the year 1953, the commercial paper rate was 2.52%.
The percentage of unemployment, 2.5%.
In the year 1954, the commercial paper rate was 1.58%.
The percentage of unemployment, 5%.
In the year 1955, the commercial paper rate was 2.18%.
The percentage of unemployment, 4%.
In the year 1956, the commercial paper rate was 3.31%.
The percentage of unemployment, 3.8%.
In the year 1957, the commercial paper rate was 3.81%.
The percentage of unemployment, 4.3%.
In the year 1958, as of June, the commercial paper rate was 1.54%.
The percentage of unemployment, 6.8%.
Unemployment percentages before 1957 are based on Department of Commerce old definitions
of unemployment.
For 1957 and 1958, they are based on the new definitions, which make unemployment slightly
higher, 4.2% of the labor force in 1956, for example, instead of the 3.8% in the table.
It will be noticed in this table that though the commercial paper interest rate in this
period averaged 2.24% or three times as high as that in the seven years from 1934-1940,
the rate of unemployment was not higher but much lower, averaging only 4.2% compared with
with 17.7% in the 1934 through 1940 period.
And within this second period itself, the relationship of unemployment to interest rates
is almost the exact opposite of that suggested by Keynesian theory.
In 1949, 1950, 1954 and June of 1958, when the commercial paper interest rate averaged
about 1.5%, unemployment averaged 5% and over.
In 1956 and 1957, when commercial paper rates were at their highest average level of the
It is very difficult, if not impossible, to prove a positive proposition in economic theory
by the use of statistics, but it is not difficult to disprove such a proposition unless it is
elaborately qualified by statistics.
We must conclude at least that neither deficit spending nor cheap money policies are enough
by themselves to eliminate even prolonged mass unemployment, let alone to prevent unemployment
altogether.
Race with the Printing Press
But these are the chief Keynesian remedies for unemployment.
In 1936, reviewing the general theory, which had appeared in the same year, Professor Jacob
Weiner ventured a prediction.
Keynes's reasoning points obviously to the superiority of inflationary remedies for unemployment
over money-wage reductions.
In a world organized in accordance with Keynes's specifications, there would be a constant
race between the printing press and the business agents of the trade unions, with the problem
of unemployment largely solved if the printing press could maintain a constant lead, and
if only volume of employment, irrespective of quality, is considered important.
This characterization has proved, in part, remarkably prophetic.
There may be some doubt whether the problem of unemployment has been largely solved.
But we have certainly been trying to solve it since 1936 in accordance with Keynes's
specifications, and we have certainly embarked upon a race between the printing press and
and the Trade Unions.
And our failure to solve the problem of unemployment, even by this method, is partly the result
of a development Professor Weiner could hardly have been expected to foresee.
The spread of escalator clauses in labor contracts, which provide not only for automatic increases
with every increase in the cost of living, but for so-called productivity increases which
come into effect whether marginal labor productivity actually increases or not.
The truth is that the only real cure for unemployment is precisely the one that Keynes's whole general
theory was designed to reject.
The Adjustment of Wage Rates to the Marginal Labor Productivity or Equilibrium Level.
This does not mean a uniform and block adjustment of the wage level to the price level.
It means the mutual adjustment of specific wage rates and of prices of the specific products
various groups of workers help to produce.
It means also the adjustment of various wage rates to each other, and of various prices
to each other.
It means the coordination of the complex wage-price structure.
It means the maintenance of a free, fluid, dynamic equilibrium, or a constant tendency
towards such an equilibrium through the economic system.
In sum, neither government spending nor low interest rates nor an increase in the money
supply is either a necessary or a sufficient condition for the existence of full employment.
What is necessary for full employment, using the word in a working, practical sense, is
a proper relation among the prices of different kinds of goods and a proper balance between
between costs and prices, particularly between wages and prices.
This functional balance will tend to exist when wage rates are free and fluid and competitive,
and not dictated by arbitrary union coercion.
When this balance exists, full employment and maximized production and prosperity will
tend to follow.
When this balance does not exist, when wage rates are pushed above the marginal product
of labor and profit margins are doubtful or disappear, there will be unemployment.
The presence or absence of monetary inflation, in brief, is by itself irrelevant to full
employment.
All that government policy needs to do, besides keeping the currency sound, is to enforce
the laws against violence and intimidation, and to repeal the laws which confer exclusive
legal privileges and immunities on union leaders, or abridge the freedom of employers and individual
workers to bargain.
As Professor Sylvester Petro has put it, the legal reforms needed may all be subsumed under
a single heading, unqualified supremacy of the principle of free employee choice.