The 1960s
"I say that the time-tested rules of financial policy still apply.  Spending for spending's sake is patently a false theory... In effect we are stealing from our grandchildren in order to satisfy our desires of today....Imagine how much better the country would feel if it had no debt at all but a healthy surplus."

"the great enemy of truth is very often not the lie - deliberate, contrived, and dishonest - but the myth, persistent, persuasive, and unrealistic."

The second world war had put on hold the policy debates between the Classical and Keynesian economists, although in academia the Keynesians quickly established their dominance. What the war made very clear was that aggregate demand could have a definite impact on the economy. Between 1938 and 1944 output surged by 13 percent per year, the unemployment rate fell from 19 percent to 1.2 percent, and inflation remained under control.

What remained unresolved was whether this experience could be repeated in a peacetime setting, and to what extent the government should remain involved in managing the macroeconomy.  The concern among opponents of the type of expansionary fiscal policy proposed by Keynes was the expansion during the war, which took place with little inflation, could not be duplicated in peacetime. Inflation was kept in check during the war only by extraordinary measures, price controls and rationing, and neither could be expected to be put in place in a peacetime economy.  On October 4, 1942 the New York Times reported that Roosevelt had appointed Associate Justice Byrnes of the Supreme Court to be Director of Economic Stabilization to "command the war upon inflationary living costs, and ordered the immediate stabilization of farm prices, urban and rural rent, wages and salaries paid in industry."  Byrnes was very much aware of the possible interpretation of the rising power of the government when he responded to a question concerning the location of his new office. "It is in the left wing, but there is no political or economic significance in my assignment there."   

In the absence of these external controls we could expect expansionary macro policies to produce less of an output effect and more of a price effect - fewer jobs and higher prices. These fears were heightened in the post WWII period when the unemployment rate rose sharply, GDP declined, and inflation reached above 20 percent per year.  The years following World War II were also a time of labor unrest, the most notable being the national rail strike, and in June of 1947 the Taft-Hartley Act was passed, the "first peacetime Federal restraint of power of labor unions in half a generation." (NYT June 24, 1947).  

The situation seemed to improve little in the early 1950s.  Wage and price guidelines were once again imposed by the federal government, this time to eliminate the inflationary pressure of the Korean War.  In 1952 the Wage Stabilization Board recommended a wage increase for steel workers, but the steel companies refused to grant the increase, and in 1952 President Truman ordered the mills seized.  The mills were to be run by the government, but in June of that year the Supreme Court voided the steel company seizure and a bitter strike followed the return of power to the companies.  Once the strike was settled, however, America turned its attention back to building the highways and suburbs that were reshaping the nation's landscape, and in those homes they could be watching color TV in air conditioned comfort (mid 1950s) or listening to small transistor radios (1953).  At work they were Xeroxing documents (1948) and likely to be seeing reduced costs and displaced workers, the result of the installation of LARGE computers, distant relatives of Eniac that debuted in 1946. On the roads the odds were still high that someone would be driving a large car produced by one of the Big Three auto companies (GM, Ford, Chrysler), but by the end of the 50s we were seeing the first wave of small cars.  American Motors and Studebaker had successful lines of small cars and in 1959 the Big Three introduced their own small cars - the Corvair, Falcon, and Valiant.  We were also beginning to see the first real signs of auto imports as the Volkswagen bug appeared as did the first small cars from Toyota and Nissan. 

On the political side, there were real fears raised by the growing menace of Russia - the Cold War was still anything but cold.  In 1947 the National Security Act allowed creation of the CIA and the House Un-American Activities Committee opened hearing into Communist influence in the movie business, and in the following year Russia closed down Berlin to land and water traffic.  That was also the year that the US launched the Marshall plan designed to create economic stability necessary for the survival of democratic institutions in Europe.  Mounting unemployment and poverty in Europe were seen as breeding grounds for the communists, and the Marshall Plan simply continued the aid dollars that had begun to flow earlier to Greece and Turkey under the Truman Doctrine.  

In the following year Russians tested an atomic bomb and the revolution in China was completed when the Nationalists fled to Taiwan.  This set the stage for Senator McCarthy's speech on February 9, 1950 at the Republican Women's Club in Wheeling, West Virginia where he started by saying "I have in my hand a list of 205 cases of individuals who appear to be either card-carrying members or certainly loyal to the Communist party."  In June of 1950 the North Koreans launched their attack on South Korea, and in 1951 the Rosenberg's were convicted of espionage.  One outgrowth of this was growth in the CIA  - a tripling of employees in the first half of the decade.  Another was US "aid" to help establish "correct" governments around the world - Iran and the Philippines (1953) Guatamala (1954) and Lebanon and Indonesia.

McCarthyism died out in 1954 when the US Senate voted 67-22 to condemn him for "conduct contrary to Senatorial traditions," but the climate of fear that he created lived on and on October 4, 1957 the Russians opened a new dimension to the "war" when they started the space race with their launching of Sputnik - a 184 pound satellite with two radio transmitters.  The Russians had beaten the US into space and triggered national soul-searching, including questions of the adequacy of an education system that was deemed far behind in science and mathematics. Lyndon Johnson, the Senate Majority Leader from Texas, held hearings to determine the extent to which the US was in the "space race" and took the lead on taking the US to the stars.  And things got worse when on November 3, 1957 a second spacecraft was launched into orbit, this one carrying a dog named Laika. When the US response, Vanguard, lifted off from a launch pad on December 6, 1957 things got even worse as the rocket managed to barely make it off the pad before it fell back to earth. Finally on January 31, 1958 Explorer was launched and the US was back in the ‘space race,’ but we were in the position of catching up.

Internationally, the war had obliterated much of the productive capacity of Europe and Japan, as well as the gold standard that had facilitated the international flow of goods and capital.  In the aftermath of the war, the US took a much more active international role in an effort to foster economic growth abroad and rebuild an international exchange system.  In our discussion of the 1970s we will examine more closely the Bretton Woods exchange rate system that replaced the gold standard, and the Marshall Plan that provided the funds necessary to rebuild.

On the issue of monetary policy, the extreme positions of the monetarists and Keynesians were softened as both conceded that money did matter, at least a little bit, and changes in the money supply could alter output. The major debate centered on the role of the Fed which had kept interest rates low during the war to facilitate the financing of the war. By pegging interest rates, however, the Fed had given up control of the money supply - a situation similar to what existed in the early 1930s. There were some who wanted to see this practice continued, very possibly because any freeing of interest rates would result in higher rates that would reduce the value of existing bonds investors owned. Supporters of the status quo supported their position by raising the specter of a link between high interest rates and depressed demand. The result of the debate was the Treasury Accord in 1951 where the Fed gained its independence.

The real issue in the 1960s, however, was fiscal policy.  At least on the 'books' the government was committed to macroeconomic management of the economy.  The Full Employment Act of 1946 was passed which established the maintenance of full employment as a responsibility of the government and the Council of Economic Advisors was established to oversee this process.  According to the law, "The Congress hereby declares that it is the continuing policy and responsibility of the Federal Government to . . . promote maximum employment, production and purchasing power."

Keynesians saw little to discourage them.  Armed with their theory of the macroeconomy and new data series on Gross National Product that began in 1941, policies could be established to steer the economy toward full employment and achieve the goals set forth in the 1946 legislation.  Just as managers would guide the operation of the large corporations, economists would manage the macroeconomy - a little more spending here, a little less money there.  This was the message in Paul Samuelson's introductory textbook which hit the market in 1948.  There was every reason to believe that we were entering what Robert Heilbroner called the "Golden Age of Capitalism,"  and that by the end of the decade we would be reading obituaries of the business cycle.

The reality, however, was quite different.  The legislation that eventually passed was a second,  watered down version of the original proposal.  In the end, the conservatives were not successful in blocking the full-employment legislation, but they were successful in raising a number of concerns with the accepted Keynesian theory and effectively gutting the legislation.  The Full Employment Act would certainly not provide the basis for aggressive Keynesian policies. 

And the 1950s offered little solace for those looking for a return to the "good old days" before the depression, or for evidence that Keynesian economics had gained political acceptance.   Eisenhower's views on the potential role of discretionary fiscal policy are evident in his critique of the Kennedy tax cut proposal.  In May of 1963 in the Saturday Evening Post in May of 1963, Eisenhower wrote:

"I say that the time-tested rules of financial policy still apply.  Spending for spending's sake is patently a false theory... In effect we are stealing from our grandchildren in order to satisfy our desires of today....Imagine how much better the country would feel if it had no debt at all but a healthy surplus."

And if we look carefully at the track record of the federal deficit, we find that even during the New Deal era, the budget deficit remained relatively small - averaging approximately 3 percent of GDP for the decade. There was no evidence that there was a will to implement any peacetime Keynesian policies.  Fortunately, pent up household demand from the war, coupled with foreign demand as Europe attempted to rebuild after the war, offset the sharp drop in federal spending following the war.  The construction of the interstate highway system and the suburbanization of the US also helped keep spending up. 

The contractionary fiscal policies of the Eisenhower years most certainly slowed growth and provided little cushion for the two severe recessions.  In the 1950s the US economy suffered through two major recessions, 1953-54 and 1958.  In the second of these recessions, the unemployment rate reached 7.8 percent, a rate not seen since 1941. The rising unemployment was reflected in slower growth which also made it to the political agenda. During the Eisenhower presidency economic growth averaged less than 3 percent a year and by 1960 the evidence was mounting that growth in Europe and Japan exceeded US growth.  It was time to "get the country moving again."

This was precisely the message of John F. Kennedy who attempted to focus the 1960 presidential campaign on one issue - the state of the economy.  According to Kennedy, the economy had been growing sluggishly during Eisenhower's term in office which had allowed the US to slip behind. While some would claim that the Kennedy victory over Nixon, Eisenhower's vice president, hinged on Kennedy's effectiveness in the new medium of TV, there is no doubt that the state of the macroeconomy hurt Nixon's chances. The American people had been sensitized to the macroeconomic performance of the economy. Those older than thirty, the majority of the voting public, had lived through a decade long Depression with unemployment rates that reached 25 percent and they had serious doubts about the traditional view that unemployment was their fault. They had also lived through a monstrous war and the painful post war conversion in which they experienced the worst of both worlds - double-digit inflation and a double-digit output decline.  They were ready to sign on to Kennedy who would lead the US into the New Frontier.

To get the economy moving again, Kennedy surrounded himself with academic economists well trained in Keynesian macroeconomic theory under the leadership of Walter Heller, Chairman of the Council of Economic Advisors.  This was the beginning of the "new economics."

"Economics has come of age in the 1960s.... The paralyzing grip of economic myth and false fears on policy has been loosened, perhaps even broken.  We at last accept in fact what was accepted in law 20 years ago in the Employment Act of 1946, namely, that the federal government has an overarching responsibility for the nation's economic stability and growth.  And we have at last unleashed fiscal and monetary policy for the aggressive pursuit of those objectives.
    These are profound changes.  What they have wrought is not the creation of a 'new economics,' but the completion of the Keynesian revolution - 30 years after John Maynard Keynes fired the opening salvo." Walter Heller, New Dimensions of Political Economy, 1966 (1-2)

The idea of a peacetime tax cut first surfaced in the Spring of 1961 with Heller leading the call.   Kennedy had also been embroiled in a heated debate with steel industry executives after they ignored the guidepost programs for wages and prices and indicated their desire to raise prices in April of 1962.  Although Kennedy faced down the executives, the general outlook was grim.  A sense of urgency was added in the summer of 1962 after the stock market sustained its sharpest single-day decline since 1929. In June Kennedy responded and delivered a speech at Yale in which he declared "economic independence" from "economic mythology" of the past - a prelude to his call for a massive tax cut in 1963.  As Kennedy saw it, " the great enemy of truth is very often not the lie - deliberate, contrived, and dishonest - but the myth, persistent, persuasive, and unrealistic."  The myth, as Kennedy saw it, was the belief in a balanced federal budget. 

The battle lines were drawn, between those who supported a tax cut to speed up growth and those who supported "orthodox budget balancing." We were entering another round in the "proper role of the government" debate - a round in which we encountered a number of extensions in the Keynesian analysis. The discussions at that time centered around two issues, short-term performance over the business cycle and long-term growth. Here we will examine more closely the short-term issues, and hold off on the long-term until a discussion of growth in the 1980s.

When discussing the short-run features of the US economy, the ultimate question was, can discretionary macro policy be used to fine-tune the economy and eliminate the business cycle?  Could the anti-depression Keynesian model be adapted to an anti-recession model that would provide policy makers with the means to defeat the business cycle.   Kennedy clearly thought this was possible, as we could see in the 1962 Economic Report of the President. 

   "Until we restore full prosperity and the budget-balancing revenues it generates, our practical choice is not between deficit and surplus but between two kinds of deficits: between deficits born of waste and weakness and deficits incurred as we build our strength... 1962 Economic Report of the President January 1963

Others, however, were less convinced of the merits of discretionary fiscal policy and the budget deficits associated with it. The concerns of the opponents are reflected in the testimony of Dan Throop Smith, former Assistant Secretary of the Treasury for Tax Policy under Eisenhower, before Senate Finance Committee in October of 1963.  As Throop saw it,

"The tax bill before you, ... seems on balance to be a bad piece of legislation. ... The country cannot afford economic experiments which are almost certain at some time or other to weaken confidence in the dollar, both internally and externally.... [D]eficit spending...was tried and presumably discredited in the 1930s.... Not only is a large tax reduction foolhardy, it is also likely to be futile in dealing with the most serious aspects of our very real problem of unemployment.  In recent months there has been increasing recognition of the fact that unemployment is concentrated in particular groups of the population... and [m]onetary and fiscal measures cannot solve the problems of structural...unemployment..."

Eventually, however, the Keynesians came to dominate economic thought and policy in the 1960s.   This was apparent to all when on December 31, 1965 Keynes appeared on the cover of Time magazine and the cover story identified his theories as the 'prime influence on the world's free economies..."  Policy makers have "used Keynesian principles not only to avoid the violent cycles of prewar day but to produce phenomenal economic growth and to achieve remarkably stable prices."

One thing was certain, if Keynesians were to defeat the business cycle and deliver on the promise mentioned in Time, a prerequisite would be a better understanding of the macro economy.  There would be a need to work through some of the "details" that could be ignored during the Depression.  We will begin with a more detailed discussion of aggregate demand which Keynesians saw as driving the economy.  The developments of the 1960s also prompted some important modifications of the Keynesian analysis and therefore we will find it was necessary to account for inflation and timing issues. The growth of interest in fine-tuning the economy also created a whole new 'growth sector' in the economics profession - short-term macroeconomic forecasting became an essential piece of the stabilization policies.  We will close out the unit with a brief overview of macroeconomic forecasting.