Evidence
“However beautiful
the strategy, you should occasionally look at the result.”
Winston Churchill
Sooner or later arguments over policy must actually refer to
the real world. England,Portugal, Ireland ,Spain and Greece have adopted
policies favored by traditional conservatives in the US. Some of the countries
are in crisis because of government squandering financed by borrowing, others
by real estate and financial bubbles in the private sector (England, Ireland,
and Spain) It may be useful to examine the preliminary results of following
these policies. Is fiscal austerity a path to prosperity when starting from a
position of financial crisis and severe recession?
The short answer is no. All of the countries listed are in deep
recession (in fact one could argue that Greece is in a depression) and recovery
is not at hand. Recovery is a complicated process and requires two sets of
policies. The first one is aimed at recovery and the second one focuses on
sustainability. Once you dig out, you want to stay out.
The shovels are monetary and fiscal policies designed to
increase total spending and encourage sustained growth. This task is trickier
than it sounds because one must account for the affect of actions on the
spending response of the general population to policy actions. This induced
effect imposes limitations on the effectiveness of policy. It is possible but
not entirely plausible, that private sector, consumers in particular, could
take actions that offset fiscal stimulus or fiscal contraction. Evidence for
this would be private saving varying inversely with the budget surplus or
deficit. This would indicate that changes in consumer spending would act to
offset government fiscal policy. This argument is made by some conservative economists.
All that is lacking is evidence. The growth in deficits during the Reagan and
Bush2 Administrations were not accompanied by increased personal savings rate
but by more consumption.
It seems clear that if private sector actions do not fully
offset the effects of increased public expenditures or tax cuts the federal
actions will increase or decrease total spending, hence GDP. Historical
evidence suggests that monetary and fiscal policy do make a difference but not
immediately and not of the magnitude once thought. Tax cuts are not totally
spent, federal expenditures are generate less additional spending than once
thought and the creation of bank reserves do not immediately increase lending
by significant amounts. Evidence has tempered views on policy effectiveness.
But, less effective does not mean ineffective.
Those who argue that economic healing can only occur through
a natural process (Austrian Economists in particular) do not have evidence on
their side. If one reviews the evidence on the rate of economic recovery from
the Great Depression among the western economies the evidence is strong for
proactive intervention. Countries that left the gold standard recovered faster,
and those countries that were most expansive in their monetary and fiscal
actions recovered more rapidly. The United States and France were among the
slowest to recover and followed the most conservative monetary and fiscal
policies.
Ben Bernanke the Chairman of the Federal Reserve is a
student of the Great Depression and was profoundly influenced by Milton
Friedman and Ana Schwartz’s history of monetary fluctuations (A Monetary
History of the United States 1867 to 1963). That study provides ample
documentation of the Federal Reserve’s policy errors during the Great Depression.
In their view, the Fed’s initial monetary restriction in the 1929-33 time
period converted a recession into the Great Depression. Their continued
conservatism hampered the ensuing recovery. The Chairman’s own academic
research has reinforced the Friedman/Schwartz study.
It must be admitted that many of the New Deals economic
proposals were economically incoherent ( a view shared by Keynes) and
represented experimentation without
theory. But many of the infrastructure and direct employment programs were
stimulative, they were just insufficient. For example, the deficits in Reagan’s
first term averaged about 4% of GDP. The New Deal peacetime deficit only
averaged about 2.6% of GDP. How far we’ve come.
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