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David Frum, commenting on the Keynes vs Hayek rap video released last week, makes a point that I noticed throughout the video as well:
The economic question we have faced since 2008 is not: “Shall the government of the United States dictate prices and production throughout the US economy?” Who advocates that? Not Larry Summers. Not Tim Geithner. Not Ben Bernanke. And if there’s any tiny remaining sliver of Barack Obama’s being that wishes for central planning, it to this day remains profoundly hidden beneath all his contrary appointments, policies, and pronouncements.
Throughout the video, “Keynes” asserts that in a depression, we need to start the flow of spending, to boost aggregate demand to a level in which the economy can sustain itself. Keynes, and modern Keynesians, believe(d) that fiscal policy could take up the torch of private spending while household balance sheets were mended, and that the boost in GDP would help us recover more quickly. And, while “Hayek” had some really brilliant lines throughout the video (“…if every worker was staffed in the army and fleet/we’d have full employment and nothing to eat…“, and my favorites: “…jobs are a means, not the ends in themselves/people work to live better, to put food on the shelves/real growth means production of what people demand/that’s entrepreneurship not your central plan…” and “…the economy’s not a car, there’s no engine to stall no expert can fix it, there’s no “it” at all…“), you’ll notice that through nearly all of the video, he is making a generalized argument against central planning. They’re talking past each other, or at the very least perceiving themselves as having two different conversations.
However, Frum runs into trouble with this:
The Hayek character says, “I feel for the suffering, I’m not some kind of jerk.” The Keynes character answers, “Now my old friend, I’d never reject you as if you were heartless, you know I respect you.”
But the suffering want more than “feeling.” They want a policy response. And it is precisely a policy response that our modern self-described Hayekians preclude. Monetary policy? No can’t do that – it only leads to inflation and more bubbles. Stimulative government spending then? No that’s out, it leads to inflation, bubbles, etc. Tax cuts for the ordinary working person such as the payroll tax holiday? No way – we must balance the budget. So that leaves only supply-side tax cuts aimed at the upper-income brackets. balanced by large immediate budget cuts in Medicaid, food stamps, unemployment insurance. Does anybody believe that such a policy mix will lead to rapid employment growth? The Heritage Foundation claimed so, for approximately 48 hours, but now even they have abandoned that assertion.
To the question: What do you do in a deflation, Keynes offered an answer. He intended his answer as a means to preserve exactly the kind of spontaneous order praised by Hayek. Keynes lived and died a liberal in the old sense of the term. There are many criticisms of the Keynesian answer, mostly having to do with that long term that he so famously shrugged off. But some answer is better than no answer – and much better than the answer offered by the modern self-described Hayekians.
I don’t know about “modern, self described Hayekians” (actually I do, but I don’t want to speak for them), but this wasn’t Hayek’s position at all. As Larry White has pointed out in a JMCB article:
The Hayek-Robbins (“Austrian”) theory of the business cycle did not in fact prescribe a monetary policy of “liquidationism” in the sense of doing nothing to prevent a sharp deflation. Hayek and Robbins did question the wisdom of re-inflating the price level after it had fallen from what they regarded as anunsustainable level (given a fixed gold parity) to a sustainable level. They did denounce, as counterproductive, attempts to bring prosperity through cheap credit. But such warnings against what they regarded as monetary over-expansion did not imply indifference to severe income contraction driven by a shrinking money stock and falling velocity. Hayek’s theory viewed the recession as an unavoidable period of allocative corrections, following an unsustainable boom period driven by credit expansion and characterized by distorted relative prices. General price and income deflation driven by monetary contraction was neither necessary nor desirable for those corrections. Hayek’s monetary policy norm in fact prescribed stabilization of nominal income rather than passivity in the face of its contraction.
The bolded line is important, because if you take the Sumnerian theory of the Great Recession seriously, or even the most common explanation of events leading to the Great Contraction (’29-’32), the problem is that the monetary authority (the Federal Reserve) allowed NGDP expectations to fall off a cliff in late 2008 by passively tightening monetary policy…and that is exactly the opposite of what Hayek would have considered proper macroeconomic stabilization policy. As I understand Hayek’s NGDP rule, the central bank should stabilize M for any given V, consistent with zero aggregate growth in in the price level (PY), which would result in the type of deflationary growth that Hayek (and George Selgin) advocated.
No need to take White’s interpretation, though, here’s Hayek himself, agreeing with Keynes on the matter of deflation (though not the prescription of government expenditure, which is redundant with a NGDP level target):
On the first issue — whether to use one’s money or whether to hoard it — there is no important difference between us. It is agreed that hording money, whether in cash or in idle balances, is deflationary in its effects. No one thinks that deflation is in itself desirable.
Really, on the issue of monetary policy, I see Keynes and Hayek arguing together against the ever-popular real-bills doctrine
The debate about central planning was indeed contemporary in the 30’s, and today I think many libertarians don’t recognize or appreciate the extent to which we’ve won on that point…Hayek, indeed had a good (and I believe superior) answer to Keynesian fiscal policy…but you unfortunately won’t find it in the Keynes/Hayek video.
Note: I’m not foremost expert on Hayek, but I’m sure that if Greg Ransom (and others!) reads this blog, he will correct my errors in the comments!
Update: Tyler Cowen makes the same point in a single sentence…bet you wish I had put this update at the top ;].
Since I can remember I’ve loved reminding my audiences that economics is not morality play. It wasn’t until Paul Krugman started blogging that I realized that I must have picked it up from one of his early writings.
That virtue can sometimes be vice is one of the most fun lessons of economics. There is a perverse delight in explaining how foreign aid may impoverish the Third World but sweatshops would make it grow rich.
I can understand why many of my fellow economists were so eager to transport this insight to the political realm. Politics they argued was a fight between interest groups – a battle over the fiscal commons. There weren’t good guys and bad guys. There were just naturally self-interested people.
Tyler Cowen pays homage to this legacy in a recent NYT piece
James M. Buchanan, a Nobel laureate in economics — and my former colleague and now professor emeritus at George Mason University — argued that deficit spending would evolve into a permanent disconnect between spending and revenue, precisely because it brings short-term gains. We end up institutionalizing irresponsibility in the federal government, the largest and most central institution in our society. As we fail to make progress on entitlement reform with each passing year, Professor Buchanan’s essentially moral critique of deficit spending looks more prophetic.
Curiously Tyler refers to a rational actor model as a moral critique but then again he certainly knew Buchanan better than I.
Still, to borrow a phrase from another of my favorite economists, the only problem with this analysis is that it is at odds with the facts.
If we want to build a model of what the government spends money on we would be best to start this way: ask people what social obligations do they believe “society” has. Look around for the cheapest – though not necessarily most efficient – programs that could credibly – though not necessarily effectively– address those obligations. Sum the cost of those programs. That will be government spending.
Contrary to Jonah Goldberg and others who see Canada and the United States as examples of two clashing ideologies, they are actually examples of two different ethnic distributions. The United States is not Canada because there is ethnic strife between Southern Blacks and Southern Whites. That strife reduces the sense of moral obligation on the part of the white majority and so reduces government spending.
I want to be very clear that I don’t say this to paint those against social spending as racists. From where I sit I am betting that most of the intellectuals lined up against expanding the welfare state are naively unaware that their support rests upon racial strife. Otherwise they would realize that as America integrates they are doomed. They are fighting as if they believe they have a chance of winning. Given the strong secular trend in racial harmony, they do not.
I point this out also to show why the major Republican strategy for limiting government was doomed from the start and why I am also not particularly worried about Americas fiscal future per se.
In the 1980s some conservatives believed that they might not be able to cut government but they could cut taxes and thereby starve the beast. Rising deficits would force the hand of future governments. Spending would have to be cut in order to bring the budget into balance.
Much of the current handwringing about fiscal irresponsibility is a sense of alarm not only on the right, but throughout much of the political center, that these spending cuts are not actually materializing.
But, by what theory of government did you ever believe they would? Governments don’t look at how much money they have and then decide what they want to buy. They decide what they want to buy and then they look for ways to fund those purchases.
Divorcing the two – through sustained deficits – was only going to lead to ever increasing levels of debt. This is what we got. At no point was the beast ever starved. The peace dividend lowered government spending growth somewhat, but that was undone by the war on terror. Otherwise spending hummed along, as it always will, with the government buying things the public thinks it ought to buy.
Yet, if this is causing upset stomachs among many of my fellow bloggers it calms mine. Its quite clear how this will end. Racial strife will continue to abate. The public will coalesce around the welfare state and taxes will be raised to meet the cost.
The fundamentals do not predict rising debt forevermore. The fundamentals predict a VAT.
This is not to say I am unconcerned about our economic future. Health care costs will continue to eat up more and more of our economy unless something is done. However, trying to convince people that health care is not a social obligation a fool’s errand. The best you could do is convince them we have no obligation to the other. As the other integrates this will likewise prove impossible.
No, people will ultimately believe that health care for all is a social obligation and therefore government will pay for it. There is no more analysis to be done on that part of the question.
The only part left is looking around for the cheapest program. This is where our attention should be focused. Can we lower the cost of those obligations? Can we make medicine more efficient?
If we can there will be economic room for other things. If we can’t, well just hang in there until the artificial intelligence revolution.
There is a strong case for the prompt enactment of further timely, targeted and temporary fiscal stimulus…
Larry Summers, 2008
Remember when stimulus was supposed to be temporary, targeted, and timely? The departure from that notion by those calling for short-term austerity has been recognized and ridiculed. But there are those calling for long-term commitments and programs which are just as far afield from ideal stimulus. To wit, Michael Lind Policy Director at the New America Foundation, calling for permanent increases in the public sector and, yes, a new entitlement program for seniors.
One solution would be direct, permanent expansion of public sector employment in “quality of life” jobs like teaching, child care, public health care, and policing….
…Many democracies in Europe and Asia have had successful experiences with vouchers provided to individuals for in-home services. My colleague at the New America Foundation Lauren Damme and I have proposed a Dignity Voucher program along these lines. Qualified retirees would receive vouchers entitling them to a certain number of hours of in-home help each week.
I’d first like to point out that this is exactly the opposite of what you want in countercyclical stimulus. It’s untargeted, untimely, and permanent. At most you could defend targeted, but “make more teachers, police, and health care workers” isn’t even a very targeted goal, let alone the vast and disparate array of policies necessary to actually accomplish that. You want to argue that we could get this done quickly? Take another look what he has in mind:
Many of these victims of the Great Recession have limited skills and were employed in low-wage jobs in the luxury sectors like restaurants and retail that catered to the big spenders of the bubble economy. The goal of public policy should be to directly and indirectly provide jobs for many of these workers in service sector jobs that address the needs of mainstream Americans, like health care and education, rather than return them to dead-end menial service jobs where they will work again for the affluent.
Your not going to turn waiters and GAP cashiers into radiologists and teachers overnight. This is going to take a long time.
I understand the need to plan for the long-term health of the economy, but unlike infrastructure spending these suggestions can’t be defended by appealing to long-term growth. Instead, this is a straight up plan for a larger, more redistributive government. One of the biggest problems today is that in the long-run we can’t afford the level of government, and in the short-run we can’t afford to cut back on spending or raise taxes. A slowly rolled out, permanent increase in government payrolls and entitlements doesn’t help either, and will probably make both worse. I mean this guys is seriously arguing for another entitlement program for senior citizens. He’s actually saying this.