During the 1940s and 1950s, the debate over the government’s role in economic management centred on the issue of whether or not a mixed economy and a welfare state are desirable. The experience of the Great Depression during the 1930s began to cast doubt on the automatic coordination function, and especially the macroeconomic coordination function of the capitalistic free market economy. As a result, the Keynesian counter-cyclical macroeconomic policy function of the government became a new sub-topic within the debate, overriding the mostly microeconomic issue of resource allocation in the socialist economic calculation debate. The Keynesian economists advocated government intervention to remedy the market failures in the macroeconomic level, particularly the unemployment phenomenon. This increased the popularity for a mixed economy and welfare state, and, as a result, the government’s role continued to grow. Interestingly, the new argument for government intervention in the macroeconomic level was also strengthened by the development of macroeconomic modeling, which was partly spurred by the socialist planning theory that developed in response to the earlier debate on the possibility of socialist economic calculation.
The government macroeconomic intervention, including the finetuning of macroeconomic policies in order to maintain stable output and employment growth, turned out to be ineffective as was proven by various episodes of macroeconomic development during the 1970s and 1980s, such as the oil price shocks and subsequent misalignment of exchang rates. Perhaps the most notable case was the “stagflation” experienced by the US economy during the 1970s’ when rising inflation was accompanied by a steadily worsening unemployment rate. This development completely refuted the trade-off between the two undesirable phenomena which had formerly been taken for granted and thus nullified the Keynesian fine-tuning policy prescription which had been based on balancing the evils of inflation and unemployment, These experience in turn provided an environment for the revival of the liberal tradition : neoliberalism led by Hayek (1984a,1984b,1989), the birth of the public choice school led by J.M.Buchanan, and the surge of political conservatism led by Margaret Thatcher. Deregulation or liberalization of the private sector has become the core of economic reform in most advanced countries in recent years, and the importance of a long-term perspective in macroeconomic policy making, such as maintaining a rule-based policy, has been emphasized time and time again. It has also been stressed that government failures are due not only to excessive informational requirements, as stipulated by the Hayekian framework, but also to the inherent nature of self-seeking government officials, as seen in the public choice framework.