Bill Kristol gets it right.

In an epic first, Skeptic recommends an article by Bill Kristol in today's NYT. Kristol is so dismayed about the GOPs predicament that he commits candor in economic matters. I provide some background, quote him liberally, and suggest the Democratic Party has the same problem.

From the end of WWII until the 1970s, conventional economic wisdom was Keynesian and focused primarily on nurturing and controlling the economy by using monetary policy and government spending to keep the balance that was understood to exist between the unemployment rate and the inflation rate. There was recognition that investment was important to the economy, and stimuli such as the investment tax credit in the Kennedy Administration and lowering of top marginal tax rates seemed to pull the nation out of recession, but those initiatives were generally seen as Keynesian tools for stimulating demand. Probably the dominant view was that if demand growth continued at a healthy rate in a non-inflationary environment, investment and increased supply would naturally follow to fill demand.

This period was the Golden Age of middle class economic growth, but in the 1970s the Keynesian tools failed to control rampant stagflation. Thus, conventional economic wisdom had failed in a real world crisis, and that opened the door to a new economic doctrine. It should be noted that the new doctrine did not clearly address the specific problems of the 1970s, but the failure opened the door to all sorts of heterodox ideas, including the monetarist idea that "only money matters" which prevailed briefly and then "supply-side economics" or "Reaganomics." Kristol describes the shift this way:

Then there was a real moment of economic rethinking in the 1970s. Supply-side economics challenged demand-side Keynesians and austerity-minded conservatives by putting growth, entrepreneurship and incentives at the center of economic policy. Supply-side economics gave Ronald Reagan's G.O.P. a new and different economic agenda in 1980, and Republicans were able to become a governing party.

What Kristol doesn't say but could have is that the central tenets of Reaganomics—lower taxes (especially on capital and especially to reduce support for social welfare programs), minimal government regulation of business, expanding markets through globalization, greatly increased rewards to "innovators" and entrepreneurs, and unleashing of financial innovation to "create shareholder value" and wealth—were also accepted and acted on by centrist Democrats. Recall it was President Clinton that declared, "The era of big government is over."

We can debate causation, but our present economic situation is grimly obvious. Real middle class and working class incomes have stagnated and declined since 1973 and especially since 2001. Millions more American families recognize that the fabled American Dream is not available to them, yet they see elites living in a new Gilded Age. The whole global financial system was freed from meaningful prudential regulation and took crazy risks not seen in America since 1929. The system is now de-levering and driving down all asset prices, threatening prolonged deflation like Japan's "lost decade" or perhaps Great Depression II. Consumer demand (normally 70% of GDP) can no longer be supported by the massive credit expansion and is now crashing. Other nations are not picking up the slack in demand. This wasn't supposed to happen.

Kristol acknowledges that conservative and Republican economic doctrine has now spectacularly failed and says they have to acknowledge that and come up with a new economic doctrine or be excluded from federal government control for decades.

I don't pretend to know just what has to be done. But I suspect that free-marketers need to be less doctrinaire and less simple-mindedly utility-maximizing, and that they should depend less on abstract econometric models. I think they'll have to take much more seriously the task of thinking through what are the right rules of the road for both the private and public sectors. They'll have to figure out what institutional barriers and what monetary, fiscal and legal guardrails are needed for the accountability, transparency and responsibility that allow free markets to work.

And I don't see why conservatives ought to defend a system that permits securitizing mortgages (or car loans) in a way that seems to make the lenders almost unaccountable for the risk while spreading it, toxically, everywhere else. I don't see why a commitment to free markets requires permitting banks or bank-like institutions to leverage their assets at 30 to 1. There's nothing conservative about letting free markets degenerate into something close to Karl Marx's vision of an atomizing, irresponsible and self-devouring capitalism.

If conservatives do some difficult re-thinking in the field of political economy, they can come back. If they don't — well, there were a lot of admirable conservative thinkers and writers, professors and novelists, from 1933 to 1980. But conservatives didn't govern.

Actually, I think Kristol is being too hard on the conservatives and Republicans. The Democrats don't have an updated doctrine either and have an even more urgent need to develop one because they start governing in 65 days. The Democrats were elected because the Republicans failed, not because voters are convinced Democrats know what to do with the economy. A successful economic doctrine cannot ignore either the supply side or the demand side. Who will be the first to synthesize something in the realistic middle? I am not at all sure it will be the Democrats.