“It was felt that if the policy prescriptions of the New Economics were applied, business cycles as they had been known would be a thing of the past.”

—Hyman P. Minsky, 1968[1]

In the 1960s, the heyday of Keynesian economics, economists spoke optimistically of an end to the dreaded business cycle. Then came the stagflationary jolt of the 1970s, the credit crunch and banking crisis of the 1980s, and Japan’s depression of the 1990s. In short, the business cycle seems alive and kicking.

Now, however, comes a graph recently published by the National Bureau of Economic Research (NBER) showing that the cycle has been tamed since World War II, resurrecting the “business cycle is dead” thesis. The graph is printed below.

Source: Victor Zarnowitz, Business Cycles (NBER and University of Chicago Press, 1995), reprinted in The Economist, Oct. 28, 1995.

According to these GDP statistics, the American economy has become more stable since World War II. Expansions are longer and slumps are milder. Moreover, the trend appears to be improving, and some economists are once again predicting that recessions will disappear altogther.

Big Government: Boom or Bane?

So what do we make of this graph? I asked an MIT economist, who immediately responded, “Keynesianism works!” Then I asked a Chicago professor, who exclaimed, “Monetarism works!”

Can we surmise from this graph that big government, as reflected in activist fiscal and monetary policy, has permanently reversed the prewar ups and downs of America’s GDP?

Granted, there have been significant increases in the size and scope of government policy since the 1940s—the introduction of so-called automatic stabilizers (unemployment compensation, federal deposit insurance, Social Security), the increase in total government spending to over 40 percent of GDP, and a resolve by federal authorities to inflate in the face of any sign of economic downturn or crisis. All these policy changes have created an environment that errs on the side of inflation, rather than deflation. And an inflation-biased economy is likely to give you more boom than bust over the long term.

Of course, there could be other explanations for a milder and less frequent postwar business cycle:

—no world war since 1945;

—expanding free trade and globalization, which tends to ameliorate economic ups and downs;

—improved methods of inventory control, thus minimizing fluctuations in industrial output; and

—shifts in the economy away from volatile agricultural markets toward more stable manufacturing and service industries.[2]

The Cost of Artificial Stability: Less Growth

But there is no free lunch. Interestingly, greater stability in the business cycle has also coincided with less growth in the postwar U.S. economy. There has clearly been a secular decline in the economic growth rate, particularly the late 1960s when the size of government began to explode upward. According to real growth rates provided by Milton Friedman, the U.S. economy grew between 3 and 4 percent a year in inflation-adjusted terms between 1869 and 1969, except during the 1929-39 depression. However, since 1969, the annual real growth rate fell to only 2.4 percent, and lately, in the 1990s, the real growth rate has declined even further.

What is the cause of this malaise? A ubiquitous and unproductive state has clearly left a huge and growing burden on society. Government at all levels is strangling business and individual initiative through excessive taxation and regulation. Not surprisingly, most federal regulatory agencies (EPA, OHSA, FDA, etc.) burgeoned in the late 1960s and early 1970s—the same time the growth rate began falling. It was also the time that the government broke the last link to sound money (the gold standard).

In sum, we must not fall into the trap of supporting big government because of its allure of economic stability and a safety net. For stability may simply be a camouflage for economic lethargy and a declining standard of living. As Ben Franklin remarked, “Those who would give up essential liberty to purchase a little temporary safety, deserve neither liberty nor safety.”

Leviathan Is Not Benign

Before we join the “business cycle is dead” school, let us not forget that Leviathan is not benign. More than likely, it will blunder again in the face of a world crisis—whether it be a financial panic, a natural disaster, or a war. As Adam Smith once remarked, “There is much ruin in a nation.” According to the Austrian theory of the business cycle, as developed by Ludwig von Mises and Friedrich Hayek, monetary inflation does not simply raise prices, but also de-stablizes the economy. In a world of fiat money inflation and fractional reserve banking, business cycles are inevitable.

Just because we have avoided another Great Depression over the past fifty years does not guarantee that we will avoid it in the next fifty years. The U.S. economy may be Depression-resistant, but it is not Depression-proof.

1. Quoted in Martin Bronfenbrenner, ed., Is the Business Cycle Obsolete?(New York: Wiley, 1969), p. vi.

2. Some economists, especially Berkeley economist Christina Romer, emphasize this point and question whether there has been much improvement in postwar business cycles. See “The Postwar Business Cycle Reconsidered,” Journal of Political Economy, Feb. 1989. However, even accepting Romer’s revised GDP figures, a huge difference exists between prewar and postwar business cycles.

Source: Victor Zarnowitz, Business Cycles (NBER and University of Chicago Press, 1995), reprinted in The Economist, Oct. 28, 1995.