Economic analysis is complicated by the fact that controlled experiments are generally not possible. One cannot test different policy prescriptions on exact same economy and evaluate the different results. Arguments are made by analogy to previous circumstances. For this reason, it is difficult to conjure up a consensus among economists as to the best way to help the American economy recover from its current high unemployment and sluggishness.
There are two basic schools of thought: one that emphasizes monetary policy and one fiscal policy. Is the economy more or less responsive to controlling the money supply or federal taxation and spending, or some combination.
Milton Friedman won the Nobel prize in economics in 1976, for his explication of monetary policy and in part on his analysis of monetary policy during the Great Depression. Friedman argued that that collapse of the economy in the 1930s after its initial signs of trouble was caused the exact wrong policy followed by the central bank. The central back tightened rather than loosenes the money supply cause radical deflation and a lack of money available for investment.
The economist John Maynard Keynes is the champion of fiscal policy. Keynes has argued that federal deficits make up for demand in the private sector during recessions and provide a means for recovery. It should be noted deficits can be increased either by increased spending on reducing taxes
Since the banking crisis in 2008, the Federal Reserve has loosened the money supply about as much as it could. Perhap by this more than any other policy, the Federal Research helped avert a 1930s-like collapse in economic activity. At this point, however, the Federal Research has exhausted much of its ammunition. Interests rates are at historic lows. Monetary policy has helped, but all the Federal Reserve can do now is maintain a loose monetary policy until a strong recovery commenses.
In February 2009, after the immediate banking crisis had abated, the Obama Administration passed its stimulus package with nearly a trillion dollars of deficit spending. Results have been at best mixed. Growth remains anemic and unemployment and under employment remain much higher than the Obama Administration promised. Nobel-prize winning economist and NY Times columnist, Paul Krugman, recently argued that given the lack of economic response, we need to re-double fiscal stimulus. We note in passing that Krugman always argues from more governement spending and not reduced taxes. Either would increase the fiscal stimulus.
We submit the thesis here, that additional fiscal stimulus now would be ineffective because of collective physcology. Given the massive deficits we have already incurred, people will become more apprehensive about the future and hoard cash if the deficit increases much more. The problem was that the Obama stimulus was accompanied with health care changes and progressive agenda that promised not a one-time fiscal punch, but a fiscal trajectory that would incur even greater deficits or significant tax increases. In the face of this uncertainity, people are saving more. in anticipation of future bad times. Ironically, this fear is suppressing consumer demand. Business, also faced with uncertainty, sits greater than average cash reserves.
By creating what seemed to be a permanent and expontenially expanding deficit, rather than a short-term stimulus, the Obama Administration undermined the effectiveness of its signature economic policy. At this point, the best that can done is to reduce uncertainity by maintaining the current tax code and creating an economic plan that restrains federal spending. In any case, it will take a long time to dig out of the current situation, but if certainty returns, businesses will be more willing to invest their acccumulations of cash and consumers wil be more willing to spend some of their savings.
It’s Not the Stimulus It’s the Regulation
Saturday, August 13th, 2011Marco economics is an observational science. It is difficult to construct controlled experiments. There always seems to be enough differences from situation to situation to introduce doubt. Nonetheless, sometimes unfair, or at least unsupported, conclusions can enter the conventional wisdom. The concept of a Keynesian stimulus may suffer this fate.
The Keynesian approach suggests that during a recession the government can stimulate the economy via spending to replace economic demand from private markets. An alternative approach championed by Milton Friedman suggests that monetary policy is more important than fiscal policy.
Democrats have traditionally favored a Keynesian approach, in no small part because it provides an additional excuse for the government to initiate spending programs to address Democratic priorities.
When President Barack Obama came into office, it was natural for the progressive to institute a massive, nearly trillion-dollar stimulus. So confident were Democrats in the efficacy of the stimulus that they promised that unemployment would not exceed 8%. We were warned that if no stimulus were instituted, unemployment would reach 9%. We now know that following the stimulus, unemployment blasted past 10%. Moreover, growth remains anemic and unemployment two-and-half years after the stimulus still exceeds 9%. More disappointing is that the officialunemployment value would be far higher if so many people had not given up hope of finding a job. The lack of growth and employment has reduced revenues exacerbating the deficit.
It is rhetorically convenient to declare in the face of these facts that Keynesism is dead, believe by only those immune to the evidence. I lend far more weight to the Friedman approach and would love to offer our current situation as definitive proof.
However, let me offer a slightly heretical view. While the current situation lends no support to the Keynesian idea of stimulus, the regulatory anchor on growth makes it impossible to tell whether the stimulus has indeed failed. Perhaps It is economic uncertainty that is restraining the economy irrespective of the stimulus.
Companies are uncertain because of a massive influx of regulations. Obamacare has passed, and mountains of rules based on the legislation are still being written. Companies, particularly small ones, are reluctant to hire uncertain of what Obamacare would require of them. The Dodd-Frank bill to regulate financial markets has introduced new banking regulations. Until these are finalized and better understood, there will be a backward tug restraining lending. This is not to mention the new regulatory aggressiveness of the the EPA anxious to implement policies bureaucratically that could never be passed legislatively. The EPA has more regulatory actions pending that the Department of Human Services which is responsible for implementing Obamacare.
Imagine the metaphor of the stimulus package being a foot on the accelerator of the economic car, with a chain of regulations strapped to the bumper. The stimulus accelerator may or may not work, but the regulatory chains make it impossible to diagnose whether the accelerator is functioning properly. The Keynesian approach may deserve death, but the current situation cannot be said to have inflicted the true final blow.
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