Tuesday, January 29, 2008

Keynesian Sleight of Hand

Robert Murphy, author of The Politically Incorrect Guide to Capitalism, has an excellent editorial about the current Keynesian response to the alleged potential future recession. Murphy is quite a bit more pessimistic than I am about the current slowdown, but my only real disagreement is about timing. I don't think the public has caught on just yet to the consequences of inflation and that it will still be quite some time before the final crash of the dollar and the US economy.

First Murphy takes the Fed to the woodshed:

Last Tuesday the Fed announced a surprise rate cut of 75 basis points, the biggest cut in 24 years. Even so, the stock market plunged, with the S&P 500 shedding 1.1% during the session, bringing its total losses to over 10% for 2008.

The Fed has now painted itself into a Keynesian corner. According to old-school Keynesianism, the government faces a Phillips Curve tradeoff. It can adopt a loose monetary policy, which spurs output but leads to price inflation. Or, the government can adopt a tight monetary policy, which keeps prices under control but leads to recession.

The sobering experience of the 1970s demonstrated that this Keynesian orthodoxy was nonsense. Ultimately, printing green pieces of paper doesn’t make a society richer, it just causes prices to rise. Once citizens adjust to the constant injections of new money, unemployment returns along with massive price hikes. Thus the term “stagflation”—meaning double-digit rates of unemployment and inflation—was coined.

And then he dresses down the politician with particular emphasis on the Treasury Secretary:

The truly depressing feature of all the stimulus talk is that even someone as knowledgeable as Treasury Secretary Paulson believes a rebate is only good if the recipients “spend” it, rather than using it to pay down debts. Here we see the true insidiousness of the Keynesian mindset: In a time of recession, when we need to tighten our belts, the politicians encourage us to go buy new cars and plasma screen TVs. The idea seems to be that if we all just ignore the recession, it will get bored and go away.

Those readers who believe in the virtues of hard work and thrift know that this Keynesian mindset must be wrong, but they may have a hard time pinpointing the sleight of hand in the trick. So let me give a hint: Whether you spend $500 on music CDs or on bank CDs, that money is still “in the economy.” Everyone understands how spending money on music boosts employment in that industry, so we don’t need to explain that portion.

But people apparently don’t recognize that when you lend $500 to the bank, you are still contributing to employment and GDP growth. The bank doesn’t put this money in a tin can under the bed, after all. No, it lends it out to a business, perhaps, so it can buy a new factory, or it lends it out to a young couple, so they can buy a home. Rather than output and employment expanding in the music and retail industries, in this scenario jobs are created in the manufacturing or construction industries.

A penny saved is a penny spent, from the viewpoint of the economy as a whole. Rather than printing up new money through the Federal Reserve, or engaging in shell games with billions of tax dollars, the government should cut its own budget while we ride out the present crisis.

That's a pretty clear and correct explanation of how the economy works. Someone should inform the White House and the Congress.

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