In the summer of 1853, New Orleans was hit by a yellow fever-epidemic. It eventually killed 8,000 people (roughly 6% of the population back then). In the mid-nineteen century it was not clear what caused yellow fever and how the disease was transmitted. Scientists at the time called “analytical chemists” assumed that yellow fever was airborne and had something to do with the composition of the atmosphere, which was intensely hot and humid; they declared that there was a “lack of ozone in the air.”
According to one account of this event, “to purify the atmosphere, the Board of Health of New Orleans ordered that four hundred discharges should be fired from several six-pound cannons; but the thunder of the artillery had a fatal effect on many of the sick, throwing them into convulsions. Then another mode of clearing the air was tried. Barrels filled with tar were burned all over the city.”
Knowing in hindsight that yellow fever is transmitted by mosquitoes, we can smile at these futile measures, which far from mitigating the disease actually increased the death toll. However, we should acknowledge the moral of the story and be humble. One hundred fifty years from now, the second program of quantitative easing by the Federal Reserve to mitigate weakness in the US economy after the financial crisis may well be interpreted as a similarly bizarre measure to firing cannons at yellow fever.
Would doing nothing, i.e., “laissez faire,” then have been the better alternative? If we consider what quantitative easing 2 (QE2) has achieved so far – basically nothing – this seems pretty obvious. Comparing November 2010 with the latest available statistics, we note that housing starts in the US are still significantly below 600,000 units (to be compared with over 2 million at the peak of the housing bubble). Moreover, house prices measured by the Case-Shiller index are now lower than in April 2009. Unemployment has retreated somewhat, but its rate remains above 9%. Finally, US growth in the first quarter 2011 only posted a dismal 1.8% annualized (to be compared with the 6% of Germany or the 4% of France).
But there is a caveat to this: the argument is counterfactual because it assumes that without QE2, we would be exactly in the situation we are now. Therefore, activists will argue that without QE2, the US economy could currently be in much worse shape than it presently is.
Richard Koo, the Chief economist of Nomura Research Institute, makes a similar point in his 2008 book “The Holy Grail of Macroeconomics - Lessons from Japan’s Great Recession.” While many economists have bashed the Japanese economic, monetary and fiscal policies of the last two decades as ineffective and expensive, he sees such critique as counterfactual and argues that Japan would be in even worse shape had the policies not been enacted.
Does the counterfactual argument “if we had done nothing, then we would be worse off” always justify activism? In the New Orleans yellow fever anecdote, the alternative scenario of not shooting cannons would have led to a better outcome.
The main difference between this anecdote and monetary policy lies in the fact that the causes and transmission channels of yellow fever are scientifically established by now. However in economics, despite having thought intensively about the issue at least since the Scottish philosopher David Hume wrote about it in 1752, we economists still don’t have a common and scientifically solid understanding of the transmission mechanisms of money.
Hence, whenever the economy derails and people expect active measures to mitigate the situation, politicians and central bankers are likely to continue shooting cannons at yellow fever, pretending to know what they are doing even though the results – as in the case of QE2 – might be far less than spectacular.
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