Why Cheap Money Fails

November 24, 1958

The late Lord Keynes preached two great remedies for unemployment. One was deficit financing. The other was artificially cheap money brought about by central bank policy. Both alleged remedies have since been assiduously pursued by nearly all governments, and are still being assiduously pursued by our own. The result has been worldwide inflation and a constantly shrinking purchasing power of monetary units. But the success in curing unemployment has been much more doubtful.

In Newsweek April 28 I published a table comparing the deficits and unemployment for the ten years from 1931 through 1940. The average annual deficit in this ten-year period was $2.8 billion (equivalent to nearly $16 billion today as a comparable percentage of national income), yet unemployment then averaged nearly 10 million, or 18.6 percent of the total working force.

Does cheap money have any better record as a cure for unemployment? Here is a table covering the twelve years from 1929 through 1940 inclusive, comparing the average annual rate of prime commercial paper maturing in four to six months with the percentage of unemployment in the same year. Both sets of figures are from official sources.

In sum, over this period of a dozen years low interest rates did not eliminate unemployment. On the contrary, unemployment actually increased in years when interest rates went down. Even in the seven-year period from 1934 through 1940, when the cheap-money policy was pushed to an average infra-low rate below 1 percent (.77 of 1 percent), an average of more than seventeen in every hundred persons in the labor force were unemployed.

Let us skip over the war years when war demands, massive deficits, and massive inflation combined to bring overemployment, and take up the record again for the last ten years:

It will be noticed that though the commercial paper interest rate in this period averaged 2.23 percent, or three times as high as that in the seven years from 1934 through 1940, the rate of unemployment was not higher, but much lower, averaging only 4.3 percent compared with 17.7 percent in the 1934–40 period.

And within this second period itself the relationship of unemployment to interest rates is almost the exact opposite of that suggested by Keynesian theory. In 1949, 1950, 1954, and July of 1958, when the commercial paper interest rate averaged about 1½ percent, unemployment averaged 5 percent and over. In 1956 and 1957, when commercial paper rates were at their highest average level of the period at 3.56 percent, unemployment averaged only 4 percent of the working force.

In brief, neither deficit spending nor cheap-money policies are enough by themselves to eliminate even prolonged mass unemployment, let alone to prevent unemployment altogether.

The only real cure for unemployment is precisely the one that the Keynesians and inflationists reject—the adjustment of wage rates to the marginal labor productivity or “equilibrium” level—the balance and coordination of wages and prices. When wage rates are in equilibrium with prices, there will tend to be full employment regardless of whether interest rates are “high” or “low.” But regardless of how low interest rates are pushed, there will be unemployment if wage rates are too high to permit workable profit margins.

*Unemployment percentages before 1957 are based on Department of Commerce “old definitions” of unemployment; for 1957 and 1958 they are based on the “new definitions,” which make unemployment slightly higher—4.2 percent of the labor force in 1956, for example, instead of the 3.8 percent in the table.