Economic Revisionism

The Fiscal Revolution in America
by Herbert Stein
University of Chicago Press 526 pp $10 00

Monetary vs Fiscal Policy A Dialogue
by Milton Friedman and Walter W Heller
Norton 95 pp $3.95.

For American Keynesians February 1964 was a month to remember After more than a year of haggling, Congress finally enacted a major income-tax cut at a time when a budgetary deficit already existed and the economy of its own accord was expanding The moment was particularly triumphant for Walter W Heller who as Chairman of the Kennedy Council of Economic Advisers had patiently educated his principal in modern economics to such effect that by 1962 Mr Kennedy was prepared to accept the political risks involved in combating the time-worn identifications between public and private finance and individual and governmental virtue which still appeared dear to the hearts of many Congressional antiques Fed by happy events, the economists' euphoria lasted nearly two years Just as the Council of Economic Advisers had predicted, the pace of economic advance in 1964 and 1965 accelerated and unemployment fell to gratifyingly low levels, only midway in 1965 did prices slowly begin to stir. As enlightened businessmen purred and politicians basked in their approval, the prestige of the economists soared to new highs And why not? The Keynesians had tamed the business cycle, solved the problems of unemployment and lagging economic growth, and got the country moving again


What rang the curtain down upon this social-science idyll was the fatal combination of Vietnam and a mendacious President By the beginning of 1966 many economists (myself among them) were concluding that the combination of the previous year's escalation in Vietnam, the likelihood of further escalation, and the inflationary anticipations these policies engendered in an economy approaching full employment urgently required the therapy of an immediate increase in taxes Fiscal policy after all is reversible But the White House dog did not bark, which is to say that the Economic Report, prepared as usual by the Council of Economic Advisers, contained no recommendation for tax change

By the time the Report appeared, Walter Heller had prudently resigned, he was succeeded by Gardner Ackley, a respected expert in fiscal policy and the author of the leading text in macroeconomics. How could Ackley and his esteemed colleagues have endorsed such a Presidential policy? After all, men have been known even in the United States to resign from office and a scholar has more to suffer from his colleagues (vide the fate at MIT of Walt Rostow) than from even a vengeful President The answer is that the President thoughtfully averted a possible clash between professional conscience and political exigency by arranging to cook the statistics upon which the Council relied Mr Johnson and the Pentagon underestimated the 1966 cost of the Vietnam war by a tidy $11 billion, just about half the military outlays in that year It was this “underestimate,” based on the fantastic assumption that the war would be over by the middle of 1967, which the Council of Economic Advisers accepted in making its own estimates of government spending, budget deficit, and price change

By the time, a year and a half later, that Lyndon Johnson finally did seek a tax hike, inflation had accelerated, and by the still more distant date in mid-1968 when Wilbur Mills graciously gave the new taxes his royal assent, inflationary psychology had taken a firm enough grip so that the present combination of higher taxes, tight credit, and curtailed federal spending has still not succeeded in cooling the economy In 1969, in short, the Keynesians do not look nearly as convincing as they did four or five years ago, and it does them no good to put the blame on the politicians If the Keynesians were willing to accept credit in 1964 and 1965 for their masterly political economy, parity of reasoning now assigns to them responsibility for the later failure


The conservative economists whose voices have been drowned by the Keynesians now have their chance to counterattack Before I turn to the two counterattacks at hand, I do want to put my own view of the situation on record It is this At least until Vietnam distorted the economy like everything else, the Keynesians had very little of which to be ashamed and a good deal of which to be proud in the economic performance of America in the 1960's The present uninterrupted general expansion from April 1961 is the longest in the annals of American economic history Low unemployment, high rates of economic growth, and the Great Society legislation of 1964 and 1965 are very substantial accomplishments, especially in contrast to the unoriginality of policy and the sluggishness of economic activity which characterized the Eisenhower era As Paul Samuelson recently reminded us, there are worse things than inflation, notably unemployment

Still, inflation is undeniably a nuisance, the Nixon administration is in power, or at least in office, and the time for the revisionists is nigh Herbert Stein, long associated with the Committee on Economic Development and generally credited with the comparatively enlightened economic statements of that business group, is now a member of the Nixon Council of Economic Advisers Rumor has it that his influence is powerful enough on occasion to defeat even Arthur F Burns, the President's puissant counselor, as on the issue of the repeal of the investment tax credit What can be derived from his long, careful, and quite fair-minded history of fiscal policy from Hoover to Johnson? A first impression is that the book is somewhat mistitled A better label might have been Fiscal Evolution in America, for the burden of Stein's tale is the absence of revolutionary leaps in either policy or ideology As early as 1946 when Congress passed (Senator Robert A Taft concurring) the Employment Act of 1946, there was, argues Stein, general public agreement that the federal government had a role to play in the achievement and maintenance of prosperity

Stein is reasonably convincing in his judgment that despite a rather large quantity of old-style budget balancing rhetoric from such stalwarts as Maurice Stans at the Bureau of the Budget and George Humphrey at the Treasury, Eisenhower's economic policy was quite up to date Two of the men who influenced it, Arthur F Burns and Paul McCracken, have reappeared in the Nixon administration to the accompaniment of the general praise of their professional colleagues, even the critics among them


The contrast between the Eisenhower and the Kennedy administrations was a matter not of doctrine but of valuations As Stein puts it “If fiscal policy was inadequate from the standpoint of full employment it was because more aggressive devotion of fiscal policy to the objective of full employment was considered to entail too high a price in other objectives—eventually getting tax revision of the right kind, checking the long-range growth of federal spending, promoting economic growth, supporting international confidence in the dollar, and fighting inflation” What prevented Republicans from cutting taxes in 1958, then, was not dimness of wit but rather hardness of heart

Stein concedes that President Kennedy was “for a President” exceptionally open to intellectual argument, and he was surrounded by some truly brilliant and self-confident economists, among them Paul Samuelson, John Kenneth Galbraith, James Tobin, and Walter Heller himself By the time Mr Kennedy was ready to recommend the 1964 tax cut, something like consensus on its advisability had developed Loud as were their voices, the Congressional dinosaurs no longer had the votes to block it I have elsewhere labeled this consensus and the compromise which it embodied “commercial Keynesianism” In its 1964 and 1965 version it consisted of two or three dollars of tax reduction for every dollar expended on social programs In the two years before Vietnam escalation dissolved all manner of consensus and retired LBJ himself, it was possible both to cut taxes and to enact a miscellany of anti-poverty, education, health, and housing legislation The business community, slower to learn in my judgment than in Stein's, finally came to understand that full employment meant larger sales and higher profits


The alliance between Great Society Establishment liberals and Committee on Economic Development-style businessmen was bound to dissolve once it became impossible either to cut taxes or to increase social spending The New New Economics which Stein represents is the result of that dissolution It addresses itself within a conservative, pro-business context to the problems of an economy burdened by the greed of the Pentagon, a worrisome inflation, and the desire of its constituency for lower taxes While by no means discarding the tools of Keynesian fiscal policy, Stein is skeptical of the accuracy of economic forecasting, opposed to the frequent adjustments of economic policy which came in Democratic days to be called “fine-tuning,” and more sympathetic than his Democratic predecessors to the Eisenhower set of priorities

The grand theory of the return to the days of Eisenhower the Good is provided by Milton Friedman, quondam adviser to Barry Goldwater and undisputed leader of the Chicago school of economists. What the Chicago school and its sympathizers at Columbia, Virginia, and UCLA esteem is free markets, limited government, and money. Here as in his massive and highly influential A Monetary History of The United States 1867-1960, Mr. Friedman advocates a monetary, as opposed to a fiscal, interpretation of American business-cycle history. In his view, the Federal Reserve System through its usually mistaken policies has played a crucial role in creating recessions and inflations. Greatly to oversimplify a highly controversial position, the monetary school is convinced that what counts in explaining the level of economic activity is not aggregate demand for goods and services (the gospel according to Keynes) but changes in the quantity of money (currency plus bank deposits) which is controlled by the Federal Reserve System. Accordingly, the clue to economic stability is not to be found in fiscal policy—which ought simply to be regulated according to the public's preferences between private and public goods—but in properly conducted monetary policy which in itself is capable of generating steady growth and high employment. Granted a stable monetary environment, individual initiatives and energies can be depended upon to generate happiness, prosperity, and freedom.


Although Heller holds his own quite successfully in his dialogue with Friedman, and the Chicago school, fortunately, has not converted the entire profession, Chicago teachings are quite clearly consistent with the inclinations of a conservative, noninterventionist President. On the other hand, the counterrevolution against the Keynesians is not likely to exile fiscal policy from Washington or produce undiscriminating attachment to budgets in balance or surplus.

The rather different danger is in the retreat from an activist conception of the federal government's role in economic affairs. In America social change comes slowly, seldom, and inadequately. But when it comes at all, it is almost invariably as the consequence of Presidential initiative. Activist fiscal policy goes hand in hand with activist social policy. The new emphasis upon monetary policy accords admirably with the new quietism of social policy. I hope we all survive until 1973.

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