The Bloomberg article below tells us that Federal Reserve Bank presidents are arguing about whether the Fed should redouble its efforts to “stimulate” the economy.
Chicago bank president Charles Evans is a strong proponent of doing more. He says the main thing he worries about is historians saying the Fed didn’t do enough. This is of course the philosophy that led George Washington’s physicians to bleed him to death. They didn’t consider the possibility that their remedy did more harm than good, and each unwilling to do less than the other, succeeded in killing our founding father.
Evans also says that “Failure to act aggressively now will affect the capacity of the economy for years to come.” This is a old Keynesian argument. If the economy is sick, get it back and running by any means because the income and employment lost can never be recovered. But this is like Till Eulenspeigal’s trick of emptying the hospital beds by terrifying the patients and then claiming that everyone has been cured. Yes the patients have been put on their feet, but because the means of doing so just makes them sicker, it cannot be called a cure. When an economy is sick, what we need is a cure, which means getting all the intricate price and cost relationships back in balance. This will restore real profitability and lead to an expansion of employment. What Keynes himself called ” tricks” cannot accomplish this essential process of repair and rebalancing. Only businesses can accomplish this within a framework of genuine prices, not prices manipulated by the government.
Meanwhile Keynesians Brad DeLong and Lawrence Summers (the latter previously President Obama’s chief economic advisor) have written a paper for the Brookings Institution in which they argue that more government deficit spending, also called stimulus, also referred to as “growth” by President Hollande of France and President Obama, is not only needed. It will even help us reduce the currently spiraling out of control federal debt. Peter Orszag, President Obama’s previous Budget Director, seems mostly to agree with DeLong and Summers but forthrightly calls their idea “the Laffer Curve of the left” in a June 4 Bloomberg piece. This refers to the original Laffer curve which suggested lowering tax rates as a way to increase tax receipts, an idea that the left thought completely crackpot in prior years. Used in this way, a Laffer Curve is just something you do which is politically easy but which miraculously gets you more than politically hard policies.
In all these proposals for more stimulus we get more of the same: assumptions, hopes, nice bedtime stories with happy endings. We do not get any hard evidence that government deficit spending works, because there isn’t any, nor do we get a solid logical argument for it.
DeLong and Summers do point out that the interest costs of government borrowing are minimal, thanks to the government’s success in repressing interest rates, so that the cost of deficit spending is lower than usual. But they don’t acknowledge that repressing interest rates, interfering with some of the most important prices in the economy, is a medicine with serious side effects, side effects serious enough to make the patient much sicker and offset any stimulus from more deficit financed government spending. Nor do they acknowledge that loading on debt on top of such a pile of debt is frightening to consumers and investors. Nor is it certain that the government will be able to keep interest rates down forever, a point that Summers himself grants by calling for the government to borrow longer, a call that the government does not seem likely to heed, if only because it would inform the world that interest rates could rise.
Yes the US can respond to an economic crisis caused by too much debt, and especially too much bad debt, by borrowing and spending more. This is like an alcoholic dealing with a hangover by downing another drink. It may make him feel better for a short while. But if we proceed down this road, we are just following the disastrous Japanese path, but with the difference that we are borrowing from abroad rather than ourselves as the Japanese have mostly done.