We are now completing a 40-year political and intellectual journey whose termination seems symbolized by two events last week: The announcement of a bipartisan agreement to balance the budget by 2002; and the latest unemployment rate which–at 4.9 percent–is the lowest since 1973. These events signal the reassertion of folk wisdom over professional economics. The folk ideas that are now triumphant are the desirability of stable money (that is, low or non-existent inflation) and of balanced budgets. We don’t have either, but we do have a broad consensus that both serve the nation’s long-term well-being.
In the late 1950s, these ideas commanded popular thinking. They were regarded as prudent disciplines. Government shouldn’t spend more than it taxes; politicians ought to choose between the hurt of higher taxes and the benefits of higher spending. And stable money fostered a stable economy. But in the 1960s, these durable traditions were discarded. Economists dismissed them as old-fashioned. A bit of inflation, they argued, could lower unemployment. Wisely used, budget deficits could avert recessions.
Because these theories never delivered, we have now come full circle. The significance of the new budget agreement transcends its details or even its ability to reach balance by 2002. It lies mainly in the fact that the goal of a balanced budget has been embraced across much of the political spectrum. What people aim to achieve–even if they fall short–affects how they behave and what’s considered legitimate and illegitimate. It is only recently that a balanced budget has attained such widespread support.
The pursuit of “stable money” is also now a central aim of government economic policy in a way that it hadn’t been. Two decades ago, the phrase had vanished from economic discussion. Economists and government officials talked instead of containing inflation to tolerable levels and reconciling it with sustained economic growth and low unemployment. By contrast, the hallmark of this economic expansion has not been the promise of the Federal Reserve to maintain it forever but rather the routine warnings that government must prevent higher inflation.
Our views have shifted mostly as the result of bitter experience. Recall the record. In 1960, inflation was 1.4 percent. By 1979, it was 13.3 percent. The effort to “manage” the economy for greater stability and lower unemployment led instead to more instability and higher unemployment. Recessions were not avoided and, when they occurred, tended to be harsher. In 1975, unemployment averaged 8.5 percent. In 1982, it averaged 9.7 percent. In general, government policies grew more muddled and unpredictable, as many futile tactics–wage and price controls and guidelines, credit controls–were tried against inflation.
Meanwhile, budget discipline was lost. Since 1961, the budget has been in surplus in only 1969.
We’ve come back to older traditions because, simply, the alternatives are worse. One reason a budget agreement has been possible is that the economy has been stronger than expected, leading to lower unemployment and higher tax revenues. The fact that so many economists are so astonished merely reaffirms the superficiality of their economic understanding. Psychology matters: a lesson they’ve never truly grasped.
The 1960s’ pledge to prevent recessions made companies and workers irresponsible. They felt they could raise prices and wages without their inflationary behavior being punished by lower profits or lost jobs. Since the early 1980s, these self-defeating assumptions have given way. The unwillingness to tolerate ever-rising inflation has meant that companies and workers could suffer if their wages or prices got out of line. Economic insecurity has increased for many individuals and firms. But paradoxically, these market pressures have promoted overall stability. Companies restrain labor costs. Lower labor costs foster more hiring. Subdued inflation limits harsh anti-inflationary policies.
We are also reverting to the notion that the budget is mainly a framework for determining the role of government and less an instrument of economic policy. There is little talk now of the economic virtues of deficits. Americans are drifting toward traditional ideas: The belief that large peacetime deficits shift the tax burden onto future generations; and a faith that pleasant spending should be checked by unpleasant taxes.
The rediscovery of old virtues won’t solve all our problems. Balanced budgets aren’t always appropriate (wars and economic slumps are exceptions). And just because a government balances its budget does not mean it will operate wisely. It may spend too little or too much. Nor does a commitment to stable money, by itself, prevent slumps or brief spurts of inflation. But these folk virtues are needed for national success. Their recovery makes you wonder where we’d be now if they’d never been lost.