hence it isn't any reason to resurrect the economic doctrines of fifty years ago.

From David Friedman:

"Stimulus: The Power of Names

A well chosen name wins an argument by assuming its conclusion. Label cash subsidies to foreign government as "foreign aid" and who can be so hard hearted as to oppose them. Call subsidies to the public schools "aid to education" and you neatly skip over the question of whether additional spending in the public school system results in more education. Label something "pollution" and is no longer necessary to offer evidence that it is bad, since everyone knows pollution is bad—even thermal pollution, otherwise described as warm water. Occasionally we even get dueling names. Both "right to life" and "pro-choice" are obviously good things; how could anyone be against either?

For a more recent example, consider Obama's economic policy. Everyone—including Obama, back when he was running for President—is against deficit spending. Relabel it "stimulus" and everyone is for it. The label neatly evades the question of whether having the government borrow money and spend it is actually a way of getting out of a recession—a claim for which evidence is distinctly thin. It is stimulus, so obviously it must stimulate.

The success of the relabelling with the general public is not surprising. What is somewhat surprising is the way in which much, although not all, of the economics profession has suddenly adopted as gospel the 1960's Keynesianism that most of the profession rejected several decades back. Everyone talks as though deficit spending was a way, indeed the way, of reducing unemployment, a central recommendation of that theory.

One explanation, of course, is that government spending is popular, taxes are unpopular, so a argument that converts deficits from a problem to a solution has a lot of natural supporters. But that is not the whole story.

Another part of it is that the credit crunch seems to bear at least a family resemblance to what Keynesians expected to see, indeed believed they had seen, as the cause of depressions. Interest rates are so low that holding money makes more sense than investing it, so demand drops, so everything spirals down—underemployment equilibrium due to the economy falling into the liquidity trap. The solution they proposed was fiscal policy. The government borrows the money that was accumulating under mattresses, spends it, gets things going again.

There is, however, one small problem with this account of the present situation. The Keynesian liquidity trap was supposed to be a result of running out of investment opportunities. All the productive things that could be done with capital had been done, so firms were only willing to offer a trivial reward to investors, so nobody bothered to invest.

That story has nothing to do with what actually happened. Firms are eager to borrow money and invest. The problem is not that we have exhausted investment opportunities but that lenders don't know what borrowers, or what intermediaries, to trust, due to a malfunction of the capital markets set off by the bursting of the housing bubble. One can argue about who to blame for that malfunction and what to do about it. But whoever is to blame, it is not a liquidity trap, hence it isn't any reason to resurrect the economic doctrines of fifty years ago.

The first round of "stimulus" proposals, whatever their faults, could at least be defended as a response to the actual problem. Lenders did not know who to trust but did trust the Federal Government. So let the government borrow the money from them, lend it to the firms that needed capital, and so keep those firms from being destroyed by a temporary freezing up of the capital markets. Skeptics might express doubt as to the competence of the government to allocate capital, but at least the policy could be seen as an attempt to get capital allocated.

The current proposal has no such defense. It simply consists of borrowing very large amounts of money and spending it. Insofar as it has any effect on the ability of firms to borrow, it makes it harder, since public borrowing is competing with private borrowing. A dollar I spend in government securities floated to fund the deficit is a dollar I don't invest in a private firm."


"Don said...

"A dollar I spend in government securities floated to fund the deficit is a dollar I don't invest in a private firm."

A Dollar spent is better than a dollar saved if you're trying to avoid Debt-Deflation. There's no a priori way to determine who spends anything better. To say that, in general, A spends better or more effectively than B, says just that. In general. For me, it's really a question of ownership. I'd like most resources to be in private hands, that way, if they are spent foolishly, at least it's their foolishness. Also, in the real world, governments rely on people's acceptance or acquiescence of it. One has to try and determine what can keep the system stable during a crisis. However perfect your ideas might appear to you, no one is bound to follow them. Hence, we often compromise our theories for irenic and justificatory reasons.
That's what the stimulus is. It's a product of Political Economy, which involves other factors than economic efficiency, even in you're right about that.

"Insofar as it has any effect on the ability of firms to borrow, it makes it harder, since public borrowing is competing with private borrowing."

So competition makes it harder. So what? Doesn't all competition do that? Isn't that the point?

"It simply consists of borrowing very large amounts of money and spending it."

You speak of names. How about we change "spending" to "investing"?
Does that change anything?

"Another part of it is that the credit crunch seems to bear at least a family resemblance to what Keynesians expected to see, indeed believed they had seen, as the cause of depressions"

That's it. It's a narrative. A story that we can tell ourselves to feel better about getting out of this. In truth, it's a lot of trial and error, which is how things usually work out.

By the way, there's also been a lot of talk about Helicopter Money. People are reaching for any idea that seems to help.

"Firms are eager to borrow money and invest."

In fact, employers have been proactively shedding jobs since the end of November and reducing investment. There has been a massive change in investment.

"The problem is not that we have exhausted investment opportunities but that lenders don't know what borrowers, or what intermediaries, to trust,"

Here I completely agree. But government has a role in rebuilding that trust.Why? I don't know, but people expect the government to help build it, and that's a good reason to do so. Sadly, it will probably overshoot. Take a look at the new Trust Index. Bankers are pretty low on that.

If you want to help capitalism and the free market, a good way to begin is to make sure that people understand that we have a welfare state. That way, capitalism and the free market might not be blamed for this mess. Now there's a good example of the problem of names.
Don the libertarian Democrat

12:14 PM, January 31, 2009"