The late conversion of a famous monetarist
The death of Anna Schwartz has been marked with reverential obituaries. Her contribution to economics was making sense of historical facts to offer a guide to what should be done today. Posterity will know her as the co-author, with Milton Friedman, of Monetary History of the United States, 1867–1960, which revolutionized our understanding of the Great Depression. The pair concluded that, contrary to conventional wisdom, the slump was caused by the Federal Reserve not pumping enough money into the economy.
From this Friedman and Schwartz led a monetarist revolution that claimed that inflation, which had been thought to be caused by either insufficient supply or too much demand, was in all cases and solely caused by too large a supply of money. They led a counterrevolution against Keynesianism, which over three booming decades had driven economies into stagflation – a marriage of runaway inflation and stagnant growth that Keynesians were at a loss to explain or cure.
Although Friedman took much of the credit for the new orthodoxy, and won the Nobel Prize in 1976 for his efforts, Schwartz was more than the midwife of monetarism – she was an equal partner in its conception. When asked why she had not been awarded credit equal to the extrovert Friedman, she modestly responded: “I’m not a media person.” Like the winemaker Luigi Rossi, whose name appears second on Martini bottles, she was an important, if largely silent, partner. Just as no one ever asks for a dry Rossi, so few today remember Schwartz.
Her strength was in her strict empirical approach. A well-ordered social scientist who for more than 70 years was the mainstay of the National Bureau of Economic Research, she amassed facts, considered the evidence and made her deductions. In an age when faith-based economics has taken hold, hers was a clear voice in grasping what went on during the financial meltdown and freeze of 2008-09 and in the efforts by government to put things right.
Although Ben Bernanke was a great admirer of Schwartz, and famously said, at Friedman’s 90th birthday party: “Milton and Anna, regarding the Great Depression, you’re right. We [the Fed] did it. We’re very sorry. But thanks to you, we won’t do it again,” she did not return the compliment. In an interview given during the dark heart of the financial crisis, October 2008, Schwartz was unsympathetic to Bernanke, suggesting that just because he understood the Great Depression didn’t mean he knew what to do to avoid a repeat. She thought his loose money policy would foster hyperinflation.
“The Fed has gone about as if the problem is a shortage of liquidity. That is not the basic problem,” she said. She might have added, as John Maynard Keynes once said, that Bernanke’s cheap money solution was as hopeless as pushing on a string. She went on: “The basic problem for the markets is [uncertainty] that the balance sheets of financial firms are credible … Lending freezes up when lenders are uncertain that would-be borrowers have the resources to repay them.” The key was “all these exotic securities” that were “toxic because you cannot sell them, you don’t know what they’re worth, your balance sheet is not credible and the whole market freezes up. We don’t know whom to lend to because we don’t know who is sound.”
She thought buying troubled assets through TARP was “a step in the right direction,” but she was not in favor of bailing out banks. In that she echoed Joseph Schumpeter’s notion of “creative destruction.” “The [government] doesn’t have to save them, just as it didn’t save the stockholders and the employees of Bear Stearns. Why should they be worried about the creditors? Creditors are no more worthy of being rescued than ordinary people, who are really innocent of what’s been going on.”
Then, in a remark to warm the ice-cold hearts of hard-nosed conservatives, she added: “Firms that made wrong decisions should fail. You shouldn’t rescue them … Everything works much better when wrong decisions are punished and good decisions make you rich.”
But that wasn’t the end of the matter. A year later, when the extent of the most corrosive recession for 80 years became apparent, she offered a surprising remedy: old-school Keynesianism. “People are saving, not spending. In order to revive this economy the government will have to resume spending,” she said. “By spending, the government will require that the current inventory will be depleted and have to be replenished. And that will bring on additional production and jobs.” It seems the policy President Obama has been advocating and has been prevented by Republicans in Congress from enacting has been right all along.
Predictably, Schwartz’s late embrace of Keynes did not make news among those who prefer to parrot crackpot theories. Her strength was her independence of view, her clearheadedness about how an economy really works, her depth of knowledge about macroeconomics, her memory and understanding of past events, but above all her unimpeachable honesty. In these troubled times, when wishful thinking and mumbo jumbo pass as insight, she will be missed.
Nicholas Wapshott is the author of Keynes Hayek: The Clash That Defined Modern Economics. Read extracts here.
PHOTO: Anna Schwartz, courtesy NBER