The View From 1776

Macroeconomists Trade Punches

      http://www.thomasbrewton.com/index.php/weblog/macroeconomists_trade_punches/

Both of them are dead wrong.


Fed chairman Ben Bernanke and New York Times liberal-progressive polemicist Paul Krugman disagree about the Fed’s monetary policy.

Krugman continues to expound the view that, if the Fed accelerates its rate of creating phony dollars, consumers will go on a spending splurge and businessmen will put their excess cash reserves into expanding their operations and hiring more people.  Earlier he advocated multi-trillion dollar increases in government stimulus spending, i.e., fiscal policy, for that purpose.  To answer the fact that such policies have never worked, Krugman and his fellow Keynesian economists always say that, however huge government spending may have been, it wasn’t big enough.

There may be a short-term flare up of business activity, as with Obama’s cash-for-clunkers or subsidies for home purchases, but such stimulus spending merely pulls already-intended purchases into the immediate term.  As soon as the stimulus spending or subsidy ends, purchases drop below their earlier rate.

There is no historical precedent for a government spending its economy into prosperity.  The ultimate result is inflation and fundamental dislocation of the sectors of its economy.  It was tried, in a major way, in the 1960s and early 70s.  We got stagflation: soaring unemployment and the highest rate of inflation in peacetime history.  Franklin Roosevelt tried it in the 1930s.  After twelve years of the Great Depression, unemployment was still at 17% in 1940.

In our last major engagement with phony-money inflation, during the 1970s’ stagflation, not only did businesses not expand, many shut down entirely.  The Midwest, formerly the industrial heartland of the nation, became known as the Rust Bowl because of its abandoned manufacturing plants.  Inflation made American businesses uncompetitive with foreign producers, wiped out more than half the purchasing power of people’s savings and incomes, and dislocated huge swaths of capital investment and jobs.  People’s investible funds were plowed into inflation-proof assets like jewelry, precious metals, and art, none of which did much for employment. 

The phenomenon of leveraged buyouts led to the liquidation of long-established businesses and the discharge of their workers.  Why?  Inflation had reduced corporate profits to such an extent that the entirety of company could be bought by tendering for all of its common shares at depressed prices on the stock market.  Take-over entrepreneurs than sold off pieces of a company’s least profitable business and used the proceeds to pay off their acquisition debt.

All of that was the consequence of the Federal Reserve’s hubristic presumption that they could create just a little bit of inflation and keep it under their control.

Even Bernanke recently has stated that the Fed’s mandate to stabilize the dollar outweighs, at the present time, its duty or ability to create full employment.

Let it be noted that Fed’s announced intention to create inflation at the rate of 2% per annum contravenes its mandate to stabilize the dollar.  A stable dollar, by definition, means zero inflation.  And inflation is, also by definition, increasing the supply of fiat, paper money faster than the increase in output of real goods and services (before Nixon took us off the gold exchange standard in 1971, inflation meant the Fed’s creating dollars out of thin air in excess of the government’s gold holdings).