JANUARY 30, 2009 by SHELDON RICHMAN
Let me see if I have this straight. The U.S. government is going to borrow $819-$??? billion, largely from the Chinese (if they’ll lend it, which they may not) and put that money into people’s pockets in a hundred different ways, from paying workers for filling potholes, to extending unemployment benefits, to expanding Medicare, to weatherizing buildings, to enlarging the National Endowment for the Arts, and on and on and on. This is going to make us all richer. What would we do without those folks in Washington, D.C.?
I like to know the theory behind things. The theory behind this alleged stimulus idea is the Keynesian principle that economic depressions result from inadequate aggregate demand. We’re not buying enough stuff–either because we don’t have the money or we’re anxious about the future–and this reduces employment and incomes, which in turn further reduces demand, employment, and incomes. The economy spirals down.
If (the theory continues) the government borrows or creates money and gives it to people who are likely to spend it, such as the poor and unemployed (not those more-affluent folks who are likely to save it), the economy can recover, that is, unemployment will decline and idle resources will be pressed into service. The new recipients of the largess will drive the economic recovery by buying things, increasing the incomes of the sellers, who will then buy things, increasing the incomes of those sellers, etc. All this will stimulate investment. Now the spiral is upward. For every dollar the government spends this way, so we’re told, GDP will go up by more than a dollar. But when money is simply left in private hands, say, through tax cuts, the effect is … bupkis. This apparently is because the money will be saved, and in this story saving is the devil’s handiwork. It is nonspending, nonconsumption, which means it’s income deprivation. No one will invest the savings (so it is argued) if consumption is flagging. Keynes famously wrote that just because someone saves by abstaining from eating dinner today doesn’t mean he will be eating dinner tomorrow. So why would anyone invest? (If you reply that people typically save for a reason, you have too much common sense to play this game. Go back and take Economics 101.)
Don’t Just Stand There–Spend!
There’s been a good deal of wrangling over how the government should spend the “stimulus” money. But to a good Keynesian this must be frustrating because it really doesn’t matter how the money is spent, as long as the government spends it–and quickly. For a long while I thought the Keynesian theory was surely more nuanced than that. But I was wrong. I recently listened to a podcast conversation between Russell Roberts and Keynesian Professor Steve Fazzari of Washington University during which Fazzari said that paying people to dig and fill holes would be just as effective as any other spending program. The point, he emphasized, is to increase aggregate demand. (Don’t take my word for it. Listen for yourself.)
Aggregate demand is obviously down these days. We aren’t buying as much as we used to. This didn’t happen out of the blue. When housing values plummeted, many people cut back their spending because, for example, they had no housing equity to borrow against or their mortgage payment ballooned and they couldn’t refinance. As the adverse effect on institutions holding mortgage-backed securities rippled out, people became anxious about the future and reined in spending, which sent the ripples out further, resulting in more reining-in, and so on.
The question is what do we do about it. The dominant view, embodied in the “stimulus” package, is that it doesn’t matter what caused demand to collapse–we must do everything we can to build it back up, along with housing values and other macroeconomic variables. The more intelligent approach is to understand why things are the way they are so that causes and not just symptoms can be addressed.
Fixation of the Macro
As economist Mario Rizzo points out, fixation on the macro takes our eyes off the ball, namely, the micro policies and actions that brought us to this state of affairs. In other words, Rizzo writes, “Too many resources went into the housing market,” thanks to government programs. The solution, then, is not demand management through government spending or contrivances to raise home prices back to their old unsustainable, government-induced levels. Rather, “Markets should be allowed to equilibrate.” That is, housing prices must find the level at which they reflect economic reality, which in turn will reveal the value of mortgage-backed securities and the condition of the financial institutions holding or insuring them. Only when markets have sorted this out can the capital structure and prices be reconfigured in ways appropriate to real conditions and consumer preferences. That is the recovery phase.
But what about the meantime? For the government the injunction should be: do no harm. Unfortunately, harm is what government does best. As Roger Garrison says, it’s a net producer of macro instability. One way it does harm is by creating an environment of uncertainty. Will it nationalize the banks? Will it buy toxic assets? Will it bail out company X? Okay, it didn’t do it this week, but how about next week? Will taxes be raised or lowered? How will the debt be paid? Political uncertainty is not good for long-term planning. Those who insist that the private economy cannot regenerate itself ought to pay more attention to the manifold ways they help make that a self-fulfilling prophecy. Stop giving entrepreneurs and investors reasons to shrug.
Government borrowing does not inject money into the economy. It was already there. But it can and does reduce the amount of capital available for private investment. To the extent the government borrows, the economy serves politicians not consumers. This is the broken-window fallacy exposed by Bastiat. Moreover, since the Federal Reserve will monetize the debt by continuing to expand the money supply, it will set in motion all the evils that accompany inflation: investment and price distortions, wealth transfers, and calculational chaos. Any short-term illusion of recovery will be paid for with a new crisis up the road.
That said, it is unrealistic to expect politicians, who live short-term, to pay any heed to sound economic theory. The public has been taught for years that the government is the steward of the economy. If things slow
down, our “leaders” are expected to do something. A politician with both the understanding and courage to resist that expectation is as rare as a dodo bird.
If we’re going to change politicians’ thinking about the economy, we’ll first have to change the public’s thinking. We have our work cut out for us. But we have to start somewhere.