Anna Schwartz is not a name too familiar with too many Malaysians. That is a shame because her works as an economist wield great influence in this era of economic uncertainty. Read up major financial newspapers, magazines, financial news channels or leading economic blogs and one will come up an idea which she—together with the more famous Milton Friedman—advanced when they were alive: the roles of central bank in addressing economic fluctuation.
She died on June 21 this year.
Anna Schwartz collaborated with Friedman in writing A Monetary History of the United States, 1867 – 1960. The book, written in 1963, introduced the world to monetarism, the school of economics that eroded Keynesian dominance in economics and policymaking in the 1970s. The book is one of the most influential modern economic books. It belongs on the same shelf as John Maynard Keynes’ The General Theory of Employment, Interest and Money, and other great books that changed the course of human history.
Both Schwartz and Friedman pointed out that the Great Depression of the 1930s was a result of tight monetary policy. The Federal Reserve shrunk the money supply at a time when money demand increased tremendously as everybody hoarded cash in panic. The Fed should have increased the money supply instead.
This is an important revelation because the pre-1970s orthodoxy was that fiscal policy was the only real economic stabilization tool: only government spending could fight economic downturn. The first monetarists proved that was not so. Monetary policy is a credible and a better short-run alternative to fiscal policy: manage the money supply instead; expand it in times of crisis.
Fed chairman Ben Bernanke is a scholar of the Great Depression. As a member of the Fed’s Board of Governors before he became the chairman, he issued a mea culpa. “Let me end my talk by abusing slightly my status as an official representative of the Federal Reserve. I would like to say to Milton and Anna: Regarding the Great Depression. You’re right, we did it. We’re very sorry. But thanks to you, we won’t do it again,” he said.
Most central bankers have learned from the 1930s mistakes. Amid the 2008-2009 financial crisis, the Fed lowered its interest rate close to zero from above 5% in just slightly more than a year. The aggressive monetary policy, among others, is partly a lesson taught by Schwartz and Friedman.
Keynesianism was increasingly dominant especially after the Fed set its interest rate close to zero however. There is a theory called the liquidity trap: the central bank is unable to push the nominal interest rate below zero even as an even lower interest rate is warranted in a recession. That is a complicated way of saying that the central bank ran out of ammo once the interest rate had been pushed to zero.
As a matter of fact, interest rates in the US, Europe, Japan and UK were close to zero by 2009. Even so, the economy seemed to require more stimuli. The Keynesians were calling for more government spending. Indeed, governments all around the world embarked on massive stimulus spending to fight the 2008-2009 recession.
Friedman’s death in 2006 partly coincided with what now has been described as the Keynesian resurgence. As if the stars were aligned, the foremost Keynesian of our day, Paul Krugman, won the Nobel Prize for Economics in 2008. The Keynesian school returned three decades later.
Whatever the successes of the recent Keynesian approach, the cost is painful especially judging from the European experience: Keynesianism exacerbated the problem of public finance. That has turned the table again.
While Friedman’s death coincided with the Keynesian resurgence, Schwartz’s death coincided with the monetarist resurgence.
The proof is for all to see. In the US, Europe, Japan and in the UK, central banks are now at the forefront of stabilization exercises despite liquidity trap. In contrast, it is the government that has run out of ammunition to do more. Governments in Europe are paralysed as far as the stabilization policy is concerned due to economic and political realities.
The resurgence of monetarism—market monetarism to be exact—is important to advocates of small government. It yet again counters the urge to resort to fiscal policy in times of crisis that will inevitably increase the roles of government. Market monetarism does so by arguing the Keynesian liquidity trap is irrelevant by pointing out the central bank can supply as much money as it is necessary without much adverse impacts as long as there is demand for it.
Monetarism, yet again, provides a credible alternative to fiscal policy. That will humble those who take the government as omnipotent.
Schwartz—and Friedman—deserved to be remembered because of that.
First published in
The Sun on
July 6 2012.