For those too young to remember, the mid-1970s witnessed the first demise of Keynesian economics as the much-worshipped Phillips Curve turned positive in depicting the relationship between the rate of unemployment and the rate of price inflation, and as economic growth collapsed in response to government spending. As the spectre of stagflation stalked the land, political leader after political leader thrice denied his Saviour and turned to other economic deities for ultimate salvation. In the United Kingdom, Labour prime minister James Callaghan summarised the new consensus in a candid 1976 denunciation:
“We used to think that you could spend your way out of a recession and increase employment by cutting taxes and boosting public spending. I tell you in all candour that that option no longer exists, and in so far as it ever did exist, it only worked on each occasion since the war by injecting a bigger dose of inflation into the economy, followed by a higher level of unemployment as the next step.”
In 1981, confronted by a serious economic recession in the United Kingdom, Margaret Thatcher responded by raising taxes and cutting public expenditure in order to protect the budget. In an infamous letter to The Times, 364 economists denounced her government’s actions and demanded increased spending. I was one of a small number of free-market economists worldwide (no more than 50) who signed a counter-letter to The Times supporting the government’s actions. Events proved us right and the large majority wrong, as the British economy quickly recovered and as a vibrant United Kingdom shed its former mantle as the sick man of Europe.
In 1981, President Reagan responded to the Volcker recession with permanent cuts in corporate and personal marginal tax rates and with cuts in non-defence spending. By 1983, the US economy moved into a sustainable recovery that would bless the United States for the following 16 years of the Great Moderation.
Presidents Bush and Obama and Prime Minister Gordon Brown turned their backs on this accumulated knowledge, over the period 2007-2010, with the disastrous debt and stagnation consequences that now confront the United States and the United Kingdom. A new British government once again acknowledges the irrelevance of Keynesian economics and is returning governance of the public finances to orthodox classical principles. The recent meeting of the G20 countries has endorsed this judgment, with the singular exception of the United States.
President Obama is an economics illiterate who has surrounded himself with deadbeat hydraulic Keynesian economic advisers. Like FDR before him, he wreaks havoc on the economy of the country that he is supposed to preserve and protect. Unlike FDR, however, the public is now awakened to the failure of so-called stimulus policies. Retribution will be served upon his socialist government in November 2010; and his own final political curtain will close in November 2012.
For Keynesian economists worldwide, the second curtain is about to close. Let us hope that it proves to be the final curtain.
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