WASHINGTON — Wondering why government can't restart the sluggish economy? Well, one reason is that we are still paying the price for the greatest blunder in domestic policy since World War II. This occurred a half-century ago and helps explain today's policy paralysis. The story — largely unrecognized — is worth understanding.
Until the 1960s, Americans generally believed in low inflation and balanced budgets. President John Kennedy shared the consensus but was persuaded to change his mind. His economic advisers argued that, through deficit spending and modest increases in inflation, government could raise economic growth, lower unemployment and smooth business cycles.
None of this proved true; all of it led to grief.
Chapter One involved inflation. Increases weren't modest; by 1980, they approached 14 percent annually. Business cycles weren't smoothed; from 1969 to 1981, there were four recessions. Unemployment, on average, didn't fall; the peak monthly rate — reached in the savage 1980-82 slump — was 10.8 percent. Americans lost faith in government and the future, much as now. Confidence revived only after high inflation was quashed in the early 1980s.
Now comes Chapter Two: How the retreat from balanced budgets has weakened America's response to today's downturn, the worst since the Great Depression. It has limited government's ability to "stimulate" the economy through higher spending or deeper tax cuts — or, at least, to have a legitimate debate over these proposals. The careless resort to deficits in the past has made them harder to use in the present, when the justification is stronger.
The balanced-budget tradition was never completely rigid. During wars and deep economic downturns, budgets were allowed to sink into deficit. But in normal times, balance was the standard. Dueling political traditions led to this result. Jefferson thought balanced budgets would keep government small; Hamilton believed that servicing past debts would preserve the nation's credit — the ability to borrow — when credit was needed.
Kennedy's economists, fashioning themselves as heirs to John Maynard Keynes (1883-1946), shattered this consensus. They contended that deficits weren't immoral and could be manipulated to boost economic performance. This destroyed the intellectual and moral props for balanced budgets.
Norms changed. Political leaders and average Americans noticed that continuous deficits did no great economic harm. Neither, of course, did they do much good, but their charm was "something for nothing." Politicians could spend more and tax less. This appealed to both parties and the public. Since 1961, the federal government has balanced its budget only five times. Arguably, only one of these (1969) resulted from policy; the other four (1998-2001) stemmed heavily from the surging tax revenues of the then-economic boom.
We are now facing the consequences of all these permissive deficits. The recovery is lackluster. Economic growth creeps along at 2 percent annually or less. Unemployment has exceeded 8 percent for 41 months. But economic policy seems ineffective. Since late 2008, the Federal Reserve has kept interest rates low. And budget deficits are enormous, about $5.5 trillion since 2008.
Only one group of economists has a coherent response: Keynesians. Led by New York Times columnist Paul Krugman, they argue that the deficits haven't been large enough. If consumers and businesses aren't spending enough to revive the economy, government must substitute. Its support would be temporary until more jobs and profits strengthened private spending. Sounds convincing.