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Steady As You Go

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Steady As You Go

John Taylor’s new economic treatise would make helpful reading for our political leaders. January 31, 2012

First Principles: Five Keys to Restoring America’s Prosperity, by John B. Taylor (Norton, 240 pp., $24.95)

Millions of Americans, reeling from the slumping economy, have become skeptical about the free market and inclined to listen to proponents of discretionary economic intervention. In election years, in which all political candidates must pledge to create jobs (and pretend that they’ve done so in their former positions), even pro-market candidates cannot entirely avoid advocating government policies to boost employment. They should read Stanford University economist John Taylor’s new book, First Principles.

Taylor’s defense of free-market principles as the only engine of long-term, sustained economic growth stems not from an ideological belief in capitalism but from empirical facts. The market works because it has been proven to work. Predictability and the rule of law, Taylor argues, are the twin conditions for prosperity. Establishing and sticking with sensible rules gives entrepreneurs an incentive to innovate while helping policymakers resist interest-group pressure. Milton Friedman, Taylor’s mentor, liked to say that growth in America was a natural phenomenon engineered by entrepreneurship and innovation, when not hampered by reckless government intervention. Whenever interventionist approaches have prevailed against fixed rules and predictability, the American economy has struggled.

A brief economic history of the twentieth century demonstrates Taylor’s argument. He unveils graphs showing an unbroken connection between steady, predictable policies and full employment. All Keynesian-style interventions, by contrast, have led to inflation, slow growth, high unemployment, or chronic recession. This pattern has held in the 1930s, the 1970s, and again after the 2008 financial crisis.

Why do politicians continue to apply failed policies? Bad economic theories, argues Taylor, coalesce with the political impulse to act—to be viewed as “doing something.” Simply following proven principles, a “steady as you go” economic policy, isn’t sufficient reward for elected officials, or for some hyperactive economists. Taylor rightly celebrates Ronald Reagan as a president who stuck to such principles—with the support of the Fed chairman Paul Volcker—in the early 1980s. Despite political pressure to act against unemployment immediately, Reagan held to a strict monetary policy that would eventually deliver the high growth of the middle and late 1980s. Friedman acted as the guiding spirit behind Reagan’s approach.

Taylor shows how easily other American presidents fall under the influence of academic fashions. Reading Taylor, one gets the impression that American economic policy over the last half-century has been hostage to a theoretical debate between Paul Samuelson—the leading proponent of discretionary Keynesian intervention in the U.S.—and Friedman, the advocate of steady rules. Both men, in their time, reproduced the initial controversy between Keynes and Friedrich Hayek. A generation earlier, Keynes had invented the concept of stimulus in a time of crisis, while Hayek argued against it.

To understand American economic policy, says Taylor, pay attention to the intellectual inclination of a president’s team: this will tell us much more than party affiliation can. George W. Bush’s 2007 stimulus, for example, came as a result of his falling under the influence of some of Samuelson’s former students. And Samuelson’s disciples are fully in charge in Obama’s White House. During recessions, Republican and Democratic presidents will always be more inclined to listen to economists who recommend government action versus those who advocate a steady course guided by free-market principles. Taylor reminds us how Richard Nixon became an ultra-Keynesian in 1972, freezing prices and wages and distorting economic incentives, as he sought reelection.

Taylor also could have elaborated further on the political pull of economic interventionism. Certainly, there seems to be a built-in contradiction between the short-term goal of political expediency and the long-term benefits of sound economic policy. Taylor could have discussed Friedman’s argument for enshrining free-market economic discipline in the Constitution through a balanced-budget amendment—though such an amendment could work only if combined with a ceiling on public spending. Europeans, facing even worse economic conditions than the U.S., are currently debating a constitutional rule forbidding any E.U. country from increasing its debt beyond 60 percent of annual production (GDP). Economic history, Taylor observes, proves that a public debt beyond 60 percent brings economic trouble and political dependence on foreign assistance (currently from China).

Should the so-called “Taylor rule”— the author’s mathematical algorithm for setting short-term interest rates, which many independent central banks use to fight inflation—become U.S. law? Independent central banks like the Federal Reserve have played an important role in saving the world from inflation, yet the Fed abandoned the Taylor rule under chairman Alan Greenspan and even more so under his successor, Ben Bernanke. A compulsory Taylor rule would make the Fed more predictable, which would in turn help stabilize global financial markets.

Based on his experience advising Democratic and Republican presidents, Taylor seems to accept that discretionary economic intervention will remain attractive for political leaders, especially in recessions. Its appeal, he writes, is largely driven by good intentions, an enduring political temptation Hayek called the Fatal Conceit. (Indeed, Greenspan abandoned the Taylor rule because he wanted to foster economic growth more quickly than “steady as you go” would allow.) Yet the market, Taylor argues in this remarkably readable and convincing book, is sufficient to the economic challenges we face.

Unprincipled American economic policies, Taylor warns in his conclusion, do harm not only to the U.S. economy: they also set a bad example for countries trying to escape poverty. After the liberation of Eastern and Central Europe in the late 1980s, newly elected governments adopted free-market principles, emulating the successful U.S. model. Today, he asks, in the absence of American leadership, where will Middle East nations trying to overturn tyranny look for inspiration—the authoritarian Chinese model? Or the crony capitalism of Russia or India? With slow economic growth, widespread unemployment, and murky economic principles, the U.S. today stands in a weak position from which to promote free markets, sound monetary policy, and private entrepreneurship—the policies that would help bring the Arab world into a new era of liberty and prosperity. The absence of American economic leadership, then, has negative effects on the rest of the world.

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