Not Just a Confusion Over Monetary Policy, The Fiscal Policy Debate as Well is Confused

|Peter Boettke|

Steve Horwitz's previsou post addressed the monetary policy debate over QE, and I think Steve does an excellent job summarizing the respective positions and explaning his opposition to QE.  While Steve has focused most of his commentary since 2008 on monetary policy, I have focused most of my commentary on fiscal policy (and the connection to monetary policy).  In fact, I am at the moment finishing a new working paper on how government spending and the "economics of illusion" has killed free market capitalism over the last 6 decades.  On a recent trip my main reading was Laurence Kotlikoff and Scott Burns, The Clash of Generations, which I highly recommend.  

During a recent lecture where the topic of the current state of the economy and public policy was the topic, one of the participants challenged me with the claim that "savage austerity" was destroying Europe.  And if you follow this debate, then you know that this is the line of argument being advanced by leading economic commentators such as Paul Krugman and Richard Layard.  But similar to Horwitz's discussion of QE, I found this piece by Daniel Gros to be a measured and well-argued response.

A true 'manifesto for economic sense' would have to repeat not only Keynesianism 101, but consider the pre-Keynesian arguments about the economic distortions that result from the manipulation of money and credit, and government interventions that distort the price system, and the after-Keynesian arguments about rules versus discretion, crowding out effects, the costs of inflation, and the political economy of public debt.  You cannot just read Malthus, Keynes, Hicks, Lerner, Samuelson, and Tobin, but need to study closely the arguments of Say, Wicksell, Mises, Hayek, Friedman, Buchanan, and Lucas.  We have to consider not only short-run disturbances, but long-run consequences for economic growth.  And, most importantly, economic sense requires that we continually remind ourselves that the fiscal mess that exists in the western democracies of the EZ and US are not a consequence of the last few years, nor the last decade, but due to a 6 decade experiment in a shift away from the "old time fiscal religion" of Adam Smith and the classical political economists.

Steve has been right to emphasize since 2008 the importance of understanding Hayek's subtle position with respect to monetary policy and the need for institutional imagination in finding a fix to monetary mischief.  But the work of James Buchanan on public finance and fiscal policy is as essential.  His works Public Principles of Public Debt and Democracy in Deficit (with Richard Wagner) must be read carefully for economic sense to emerge in our professional and public discourse.

Comments

[Jerry O'Driscoll]

Milton Friedman couldn't understand how so many people have come to believe that government spending stimulates economic activity with so little evidence. As Horwitz has demonstrated, Hoover engaged in "pump-priming" before the General Theory was written, and to no end.

The "evidence" is, of course, the predictions of models, which are believed over actual experience. The same can be said for monetary stimulus in the form of QEs.

Market participants understand each new QE round causes a sugar high in the stock market with no lasting economic benefit. That is precisely why Wall Street clamours for each new round: juice the S&P 500 against fading economic fundamentals.

[McKinney]

Government spending as a way to stimulate the economy seems to have been very popular for centuries. Economists disagreed and remained very unpopular with the public. Keynes decided it was more important to be popular than right and a lot of economists followed.

The fire place near the seat of power if very warm and the crowd very friendly. Economists there get photo opps with famous and powerful people. Everyone speaks well of you, just as Hayek warned:

“The reason why I think that too deliberate striving for immediate usefulness is so likely to corrupt the intellectual integrity of the economist is that immediate usefulness depends almost entirely on influence, and influence is gained most easily by concessions to popular prejudice and adherence to existing political groups. I seriously believe that any such striving for popularity—at least till you have very definitely settled your own convictions, is fatal to the economist and that above anything he must have the courage to be unpopular…

“I think as economists we should at least always suspect ourselves if we find that we are on the popular side…”

“But the fact that, whatever may be true of the country as a whole, the ‘intelligentsia’ is predominantly left means that you are certain to have much greater influence, and therefore apparently chances to be useful, if you accept the sort of views which are generally regarded as ‘progressive’.”

Hayek “The Trend of Economic Thinking” pp 40-43

[McKinney]

Whatever happened to the idea of diminishing marginal returns? Unless it no longer applies, economists should expect successive rounds of QE and federal stimuli to result in diminishing returns. Am I missing something?

[Barkley Rosser]

2 points.

1) Kotlikoff's book is not all that great. His accounting has been repeatedly shown to be seriously wrong. See the numerous discussions by Bruce Webb and coberly at Angrybear, as well as from time to time, Dean Baker.

2) Gros's piece is less than the convincing slam dunk you portray it as, Pete. It does not note the budget balances of the three from the real starting point, their "equality" in 2007, which had much higher deficits for UK, US second, and EZ third, with its imperfectly followed fiscal targets of deficits not exceeding 3%, with much variation across the EZ. While Gros declares not much difference, in fact the US is ahead at the end and still rising, in contrast to both EZ and UK. Gros's argument really boils down to the UK, but again, it started out with the highest deficits. It stimmed, but has since gone austere. However, that has been associated with a return to recession, and that lowers its tax revenues, making its deficit look worse. Correcting for that leaves the US as the most stimulative and the best performing from 2007 to today, if not by much over the EZ.

[Daniel Kuehn]

And while we're piling on Peter's reading list, Bateman's "Scholarship in Deficit", in HOPE, is well worth reading along side the Buchanan citations. I was introduced to Buchanan early in my education - certainly before I read Keynes in the original. I've always enjoyed him and endorsed him, with the exception of almost everything he's put out on Keynes.

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