Sweet Orange

Once upon a time, in the 1930s (and part of the 1940s to be more exact), we had a depression. In fact, it was so bad that it wasn’t just called a depression; it was called “The Depression.” Along came this guy named Keynes who said I can fix that: Just have the government spend a lot of money; this will create jobs. With more jobs, people will once again have money to spend. The economy will recover.

Then enters President Franklin Roosevelt who said something along the line: Sounds good to me. So the government spent lots of money, but not as much as Keynes had thought was enough to solve the problem. Then along comes World War II, and the US government spent even more money. And, in fact, The Depression was no more. The Keynes spend-your-way-out-of-the-problem solution seemed to work!

So some thought this is a handy tool for preventing ups and downs in the market. When times are bad we can just spend a bit to tweak the economy back up. When times are good, we can cut back on spending (easier said than done).

This worked more or less until the 1970s when this thing called stagflation happened. Usually when employment is high, inflation is high and vice-versa. Not so with stagflation where we get the worst of both worlds. In the 1970s, the government spent, but unemployment and inflation both keep going up—an unusual and unpleasant combination.

The Keynesian model for handling a down economy didn’t seem to work anymore. This decades-old, preferred model for handling economic downturns became passé, and a  model that involves manipulating the money supply emerged. This model, in a modified form, came into full bloom during the Reagan administration and was the new preferred economic model for about three decades.

Tomorrow: more on manipulation of the money supply

This is Part One of a three-part series: A Little Story about our Economy
Part One: The Depression, Keynes, and Manipulating the Money Supply
Part Two: More on Manipulating the Money Supply
Part Three: Solutions?