Tuesday, February 10, 2009

Obamanomics: A Break With The Past? Hardly

To hear President Obama tell it, our current economic crisis was caused by the failed policies of the last eight years, which conveniently coincide with the Bush presidency. Does the Bush administration bear any blame? Of course. The Bush years were marked by reckless fiscal policy (monetary policy was no less reckless but that was the work of Fed chiefs Alan Greenspan and Ben S. Bernanke). Obama rejects any calls by congressional Republicans to exercise fiscal discipline regarding the current stimulus bill citing correctly that Republicans lost all credibility over the last eight years in the fiscal restraint department. However in calling out the hypocrisy of the opposition party, Obama's logic takes an odd turn; he says that the Republicans have run up a trillion dollar deficit and that he will not return to their "failed policies". Incredibly, Obama says this during an appearance designed explain his own addition of a trillion dollars to the current deficit.

For the purpose of creating political rhetoric, the President says that the policy that led to our current malaise is just in elementary school, a tender eight years of age. In fact this policy is well into its retirement years at almost eighty years old. It is great to see our seniors out in the work force refusing to retire, but this government employee should be forced into retirement. The government spending as economic savior policy has been around since Herbert Hoover, who like George W. Bush, believed that fiscal stimulus could rescue us from a depression. FDR's New Deal actually took what Hoover started and expanded it greatly. Obama plans to do to Bush's fiscal policy what FDR did with Hoover's--expand it beyond heretofor explored boundaries. So, far from breaking with the policy of the past, Obama plans to pursue old policy with ever-increasing recklessness.

Is there any justification for Obama's belief in fiscal stimulus? No, not one bit. The father of fiscal stimulus, John M. Keynes wrote:

“Organized public works, at home and abroad, may be the right cure for a chronic tendency to a deficiency of effective demand. But they are not capable of sufficiently rapid organisation (and above all cannot be reversed or undone at a later date), to be the most serviceable instrument for the prevention of the trade cycle.” -- Keynes, Collected Works, vol. XXVII, p.122

For Keynes, fiscal policy was simply too slow. It probably would not target idle resources either. He advocated monetary policy in the form of a zero interest rate, perpetual free money, to stimulate the economy as a first solution. Our problem is that we have a near zero interest rate now, with no apparent success and whole new set of central bank problems.

Not only do we know that the New Deal's fiscal stimulus, then unprecedented, failed to get us out of the Great Depression, we have also have some interesting, though rare, periods of fiscal contraction to consider. We had a depression in 1921 on the heels of World War I inflation. It had passed by the time Commerce Secretary Herbert Hoover convinced President Harding to do anything about it. Under Harding and President Coolidge, fiscal policy was contractive--the national debt decreased.

In 1947 we had another year of wrenching fiscal contraction after the massive inflation of World War II. All of the respectable Keynesian economists said this would bring on a renewal of depression-level unemployment. They were wrong. The post-war economy maintained high employment during a great fiscal contraction.

I would guess that President Obama and his advisors actually believe in the necessity of their stimulus package even as they and congressional Democrats salivate at the opportunity to fund their "pet projects". So I do not believe that Obama, as he says, hates to have to spend this money; he is relishing his role as our savior. However his crude rhetoric about breaking with failed policy of the past to bring us into a new brighter future is only persuasive to those unarmed with a knowledge of economic theory and history.

1 comment:

  1. Keynes and the Triumph of Hope Over Economics

    Author:
    Benn Steil, Senior Fellow and Director of International Economics

    February 6, 2009
    Financial Times

    This is a glorious moment to be an economist. In good times, we are mostly marginalised by the cheerful churnings of the market. But in those rare times when it all goes to hell, we are truly in our element. Now the politicians really need us. Who else can tell them how to reverse a recession by borrowing a trillion dollars? Henry Kissinger? Madeleine Albright? Yeah, right. What were their theses on?

    And indeed, we as a profession are making our voices heard in a way we never get the chance to do when the credit is flowing, businesses are investing and consumers buying what business wants to sell. Then, we make arguments based on data, otherwise known as "facts", processed through regression analysis and logical rigour, which few humans read. (I know, I am an economics journal editor.) Now, on the other hand, we call for trillion dollar stimulus plans on the basis of little more than citing John Maynard Keynes--and politicians revere us. Citing Keynes gives us special licence to talk economics without using any. To paraphrase the lawyers' dictum, when the facts are on our side, we pound the facts; when theory is on our side, we pound theory; and when neither the facts nor theory are on our side, we pound Keynes--and to great effect.

    Keynes, not coincidentally, had nothing to say about the proper components of fiscal stimulus. This allows him to be cited with great effect by both paternal progressives (who favour government spending) and caring conservatives (who favour middle-class tax cuts).

    To be sure, economists have published peer-reviewed technical analyses of the efficacy of government spending and tax cuts. But when nature fails us we console ourselves with Scripture, not science, and when markets fail us we turn to Keynes. His famous quip that "In the long run we are all dead" is a profoundly satisfying justification for borrowing a trillion dollars, right now, never mind that it contradicts an essential insight of our discipline: in the words of Frédéric Bastiat from 1848, "The bad economist confines himself to the visible effect; the good economist takes into account both the effect that can be seen and those effects that must be foreseen"--in other words, the long run.

    One of these good economists was Bastiat's fellow Frenchman Jacques Rueff, who in a 1947 journal article attacking The Fallacies of Lord Keynes's General Theory pointed out that governments "have a choice between only two solutions: to allow the apparatus of production to adapt itself to the structure which, by the movement of prices, the will of the consumers tends to impose upon it, or to adapt the desires of consumers by authoritative regulation to the structure of the productive apparatus which we do not propose to change". And insofar as the government's "investment programme diverts means of production from the areas where they are more desired to less useful employments, it will reduce the standard of living".

    But Nobel Prize-winner Paul Krugman, who calls today "The Keynesian Moment", justifies such a trillion dollar investment programme on precisely the Keynesian foundations that Rueff demolished--the claim that money "would otherwise be sitting idle". When Mr Krugman buys his stimulus bonds, I am curious where the "idle" money will come from. Will he sell stocks? Bonds? Withdraw funds from the banking system? If it is not to come from a cash box, it is not idle, and Mr Krugman can only fall back on the hope that the government will use his funds more productively than businesses can.

    But hope is precisely the platform on which President Barack Obama ran during his campaign. Hope has enabled the president to raise the estimate for the number of jobs his stimulus plan will create from 2.5m to 3m and then to 4m in the space of just a few short speeches. It is the ultimate faith-based initiative. And in the spirit of unity he promised to bring to Washington, his proposal comprised 60 per cent new spending and 40 per cent tax cuts, the same proportion as that of Democrats to Republicans in Congress. Yes, we can!

    "Thanks be to Heaven, we are thus freed from all this terrifying apparatus of economics," to paraphrase Rousseau's fictional Savoyard Vicar. "We have at less cost a more assured guide in this immense labyrinth of human opinions."

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