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Wednesday, December 10, 2008

WHY THE US WILL LIKELY AVOID A DECADE-LONG ECONOMIC CRISIS OF THE JAPANESE SORT

Today's Buggy Topic

As usual, the subject-title captures pretty faithfully the bugged-out topic today, and equally as usual, the lengthy buggy commentary unfolds at another economic blog . . . this one the Marginal Revolution, a very good web-site run by an uncommonly flexible libertarian economist, Professor Tyler Cowen of George Mason University.  The latter is a fount of free-market libertarianism . . . some of the University of Chicago sort, others of the Austrian school that deplores all central banks and fractional commercial-banks that, together, can increase or decrease the money supply in various ways. 

Free-Market Theorists Divided 

The two free-market schools --- the Chicago one far, far more influential (the Austrian one confined to a few iconoclasts in libertarian circles) --- don't really get along well with one another. 

Milton Friedman, for instance --- the most influential of the Chicago school Nobel Prize winners --- has dismissed the Austrian views of the banking system and money supply as muddled and wrong.  Moreover, the prestigious University of Chicago economists agree that there are market-failures such as environmental pollution, though they tend to argue, thanks to what's called Public Choice theory, that governments are not likely to correct them or, with some likelihood, may make them worse. 

By contrast, Austrian economists tend to argue that even mentioning market-failures opens the door to socialism.  They go on to argue that if anything like a market-failure exists, sooner or later --- usually very soon, you understand --- an enterprising entrepreneur or existing business will correct it, seeing as how any correction will reward him with profits. 

The Quantity Theory of Money Disputed or Ignored in Free-Market Economics

Only fair to point out that Friedman's key policy for stabilizing the economy --- especially in a recessionary time: in short, the use of the quantity theory of money and the expansion of the money supply --- lost favor even in free-market Chicago-style theories from the 1970s on. 

In its place, a combination of rational expectations and real business cycle theory entailed the conclusion that supply and demand in all markets was in equilibrium, except when --- as in a recession --- there were shocks to GDP at full employment that came from the "real" economy . . . above all, imparted by technological changes and innovations that prevented both fiscal and monetary policies from having any chance to affect the business cycle in a recession. 

In particular, sooner or later, the technological changes will raise the rate of return on capital investment, and the economy will on its own will return to its long-term potential growth-rate and full employment.   

If anything, efforts by monetary policymaking to shorten a recession will likely create uncertainty in the minds of savers and investors and prolong the time-period in which GDP returns to its full-employment and long-term potential.  (All free-market economists have tended since Milton Friedman's work to dismiss fiscal stimuli as an impossibility except for one change: a permanent reduction in taxes.  Any short-term reduction --- like George W. Bush's tax-cuts in 2001 and 2003 (or again last spring with a rebate) --- will not be spent wholly or at least largely by the public, it's argued.  Instead, the public knows that temporary tax-cuts that aren't linked to concrete cuts in government spending of an equal amount will lead to future taxes being raised to pay for increased national debt, and so they automatically use the tax cuts either to pay off existing debt or to save the money in financial markets . . . anyway, not spend the government "hand-out" on consumption products.

Click here for a good analysis of real business-cycle theory  --- for which two University of Chicago-trained professors, Finn Kydland (now of UC Santa Barbara) and Edward Prescott --- shared a Nobel Prize in economics a few years ago.

Keep in Mind . . .

Obviously, the existing Federal Reserve does not share this kind of strong free-market theory, any more than the current Bush-W Secretary of the Treasury, Henry Paulson . . . nor their views on the need to regulate financial markets.  And, of course, the same kind of dismissal in matters of fiscal stimuli have also marked the George W. Bush presidency for 8 years, not to mention the firm commitment of President-elect Obama to engage in a massive program of public works and other government spending to deal with the existing financial and economic crisis.

Enough Said: Here's the Buggy Commentary

It clashes with the pessimism of an extravagant sort that flourishes in certain economic circles --- among Austrians on the right and someone like Paul Krugman on the left (at times anyway) --- who think the US is likely destined to emulate the 10 years or so of Japanese slow growth, in-and-out of recessions, and deflationary tendencies correlated with severe debt-deleveraging.  Click here for the buggy criticisms of this view.