So, Congress is ruminating on recession, studying a stimulus, etc. What's up with that?
Today we consider two mythical points in space: the aggregate supply capacity of an economy and the aggregate demand. Consumers in an economy demand that producers supply goods and services, and money is the mechanism of that demand. With murmers of the 'R' word in the streets, we fear that the two mythical points have been torn asunder.
The problem, say the Keynesians, is not that the consumers don't want all that the market can supply, rathe the problem is that they lack the money necessary to demand it. The solution is to provide the money. How to do that? Well, we can lower interest rates, but they're already at 3%. With inflation somewhere between 2% and 3%, we're damned close to what I'm pretty sure they call a liquidity trap, or a situation where a bank loses money by lending. So the Fed's done most of the what the Fed can do.
When monetary policy isn't getting it done, the Keynesians turn to the fiscal. The idea is to have the government run a deficit in lean times in order to inject money into the economy, boosting aggregate demand up to meet the supply point like it should. In practice, this means increases in spending for Democrats and tax cuts for Republicans. There are different market distortions involved with each, but the idea is the same. Milton Friedman (talking about Keynesians, he wasn't one) emphasized the unimportance of the delivery mechanism by advocating that the money be dropped from a helicopter. As a side note, Keynesians would also suggest that the government run a surplus during fatter years in order to pay back the deficits incurred during the lean ones, but I bet you can guess how often that happens.
Not so fast, cry the Austrians (the part of the Austrians will be played in this election cycle by one Ron Paul). Aggregate demand was falsely blamed, they say, it was the supply all along. If demand is trailing supply, that's just because producers have foolishly gotten caught up in bubble/boom thinking and invested too much in things that aren't nearly so valuable as presumed. Real estate, for example. Last time it was tech stocks, who knows what it'll be next time. When you're faced with a hangover, the sensible lesson is to avoid the next binge.
With that in mind, injecting money is the worst idea EVER. The Fed drops interest rates, the federal government sends everybody a check for a few hundred bucks and suddenly there's a lot of money in the economy looking for someplace to go. It could go into sensible investments, providing long-term value benefiting everyone in the economy. Or it could be rashly deployed, blowing a bubble in some other industry and leading to another period of irrational exuberance, followed by another "correction" once people realize that the new emperor is no more clothed than the others. The Austrians, we can safely say, will bet on irrational exuberance over sober investments every single time the money gets cheap.
A stimulus package therefore is a suckers game. The market crashed when everyone realized that selling dogfood online wasn't the revolution it was cracked up to be. Bush, Congress and the Fed threw money at the problem, literally. Consumers took the money, avoided the stock market (won't be fooled again) and blew a big real estate bubble (okay, they will be fooled again). What happens when the real estate bubble pops? The powers that are loosen the purse strings...
So... are we smoothing the business cycle by injecting money where it's needed, or are we chasing our own tail, causing the next boom/bust cycle by responding heavily and tardily to the last? You're the judge, and Super Tuesday's tomorrow. It's a pretty lame joke that starts "so 6 Keynesians and an Austrian walk into a primary, " right?
For the record, this isn't an endorsement of Ron Paul. More of an exploration of how far away from the status quo his positions really are...
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