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The economic lure of alternative worlds

The writer, a professor of economic history at the University of Geneva, will be delivering the Penrose Lectures this week

Last week, Boris Johnson startled his audience at the CBI when he spoke in glowing terms of a family visit to Peppa Pig World. It was his “kind of place”, the British prime minister said, an alluring alternative to a real world of unsafe streets, unruly schools and creaking mass transit systems.

It seems unlikely that the UK’s economic elite will heed Johnson’s advice and visit Peppa Pig World themselves. Yet in recent years some of the sober men and women who run rich countries’ central banks have succumbed to the lure of a fantasy world of their own.

In a celebrated book published in 1963, Milton Friedman and Anna Schwartz constructed a counterfactual history in which the Great Depression did not have to take place in the United States in the 1930s. They imagined an alternative world in which there was no collapse in production, no spiralling deflation, no mass unemployment and no poverty. It was a world, they claimed, in which an ordinary recession might have occurred but not a depression. And one that could have been part of our history if only America’s central bankers had flooded liquidity into the financial system to avert its collapse.

When important people speak aloud about their fantasy worlds, it makes sense to look beyond the details. Johnson invoked a porcine world to vaunt the potential of “UK creativity” which, combined with the City of London’s capital, would usher in a green industrial revolution.

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Friedman had a similar taste for pantomime. Lamenting increased “government intervention in economic affairs” after the Great Depression, he attributed it to the widespread belief that a capitalist system was prone to crisis. But that was wrong, he protested, since the Depression was “produced by government mismanagement rather than by any inherent instability of the private economy”. Friedman’s work with Schwartz proved decisive in sustaining the claim that in the 1930s the US Federal Reserve had exercised its monetary responsibility “so ineptly as to convert what otherwise would have been a moderate contraction into a major catastrophe”. 

The alternative world that Friedman and Schwartz imagined proved so alluring that their interpretation had become the orthodoxy of the Great Depression in the US by the end of the 20th century. Economists and historians have begun to ask themselves how that happened, as well we should. But central bankers ought to wonder too why they succumbed to its lure and convinced themselves of the merits of monetary policy that was once deemed unconventional, even disreputable, but is now the “new normal”.

In 2002, Ben Bernanke offered a tribute to Friedman and Schwartz: “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.”

The rest is history. The flood of liquidity that followed the financial crisis was remarkable when considered in historical perspective. And that was before central banks responded to the coronavirus crisis with even more spectacular injections of liquidity.

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The justification for quantitative easing is built on a historical fantasy in which the world was saved from the Great Depression by a giant expansion of the money supply. Its extraordinary appeal for central bankers has meant that the illusion of money’s sanctity has been shattered.

Schadenfreude is tempting when monetarist ideology is hoisted with its own petard. Indeed, amid rising asset prices, there was a suggestion that QE could be used to fund green policies. But now talk of old-fashioned inflation is back and a dystopia is emerging as an alternative world, one in which falling production and rising unemployment appear as inevitable possibilities in a capitalist economy.


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