At the current economic juncture two camps offer diametrically opposed macro policy prescriptions. Economists on the Keynesian side such as Joseph Stiglitz and Paul Krugman advocate further monetary easing by the Federal Reserve and massive new federal deficit spending. The opposing camp includes Austrians and monetarists. Among its distinguished members is Allan Meltzer, who in a recent Wall Street Journal op-ed column argues against monetary stimulus and favors reduced government spending.
These correspond to two ways of understanding the sluggishness of the US economy, explanations based on different time horizons and levels of analysis. For Keynesians, the key is demand, which needs to be boosted by government action. For the other side, the key to slow growth and job creation is heightened uncertainty.
In part the uncertainty is caused by the European debt crisis, but also by the Obama administration’s massive new healthcare program and financial regulations, the looming Fiscal Cliff at the end of the year, and the political unknowns posed by the coming election.
Thus Mr. Meltzer writes: “Business investment is held back by uncertainty. No one can reliably calculate tax rates, health-care costs, and the regulatory burden until after the election, if then. How can corporate officers calculate expected return when they cannot know these future costs? How is more monetary stimulus today supposed to help?”
While businesses and households wait for information to achieve greater clarity, they spend less. Hence economic activity and job creation remains weak.
Ironically, it was John Maynard Keynes who highlighted the pivotal role of uncertainty, and though his followers have not developed his insight further, they generally accept it. The links between extreme uncertainty, low spending and slow growth can be expressed in a simple Keynesian model.
But as far as macro policy goes, Keynesians focus on the spending angle—that is, the result of the uncertainty, not the shakiness of futures prospects that is causing the problem. Their policy levers work on the immediate prospect of creating aggregate demand, while ignoring the effect on people’s expectations of the future. As Mr. Meltzer points out, the Fed has been pursuing short-term policies. The analysis that underpins calls for stimulus, both monetary and fiscal, is concerned with the symptom – low spending – rather than the underlying doubts of which it is a result.
In today’s conditions, this short-term and superficial viewpoint is misleading. The federal government itself caused much of the uncertainty through Obamacare, regulatory explosion, giant budget deficits, anti-business rhetoric and threats of increasing taxes. And the push for more aggressive use of Keynesian nostrums, for greater deficits and higher inflation, are further eroding confidence.
This is like bopping somebody on the head and giving them speed pills to counter their woozy state. Government policies and rhetoric beat up on the economy; this discourages activity; which in turn leads to calls to stimulate some more.
It is not really helpful, to say the least.
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