More money, more problems

by Rob Horning

8 January 2009


It’s clear our economy has run into an effective demand problem: for highly logical reasons banks are loath to lend and consumers are choosing to save rather than spend. (How dare we! After so much effort has been invested in making us slavishly consume the surplus!) This WSJ chart illuminates what it has chosen to call “the frugality trap”:

The chart illustrates how the U.S. economy’s dependence on consumer spending has grown and grown over the past few decades, but seemed to reach a ceiling in 2001. The current crisis may be an indication that the level achieved was not as stable as it appeared, but the solution the ruling class has apparently settled on is an effort to restore that level. That’s why it is a trap rather than an opportunity to reconceive our collective economic purpose. An economic reorganization to stabilize a smaller personal consumption to GDP ratio would presumably be to painful—it would seem to mean a reduction in living standards and would definitely mean growing accustomed to acquiring fewer new things—and politically unacceptable. Obama’s proposed fiscal stimulus package (a wealth of spending initiatives and, as we’ve recently learned, tax cuts) is meant to try to turn the tide against this, and the stock markets anyway seem enthusiastic about its chances.

But there remains something jarring about shoveling money at people so they will buy more, particularly since easy credit, fueling heedless consumerism, helped bring the economy to this point where it requires stimulus. Economist Arnold Kling, an outspoken stimulus skeptic, expresses the problem succinctly: “from a Keynesian perspective, you always want to transfer wealth from the prudent to the profligate. But from any normal perspective, you don’t.” This is exactly what sticks in my craw when I think about, say, plans to prevent foreclosures. Money is being transferred from the prudent people who eschewed real-estate purchases they couldn’t afford (like me) to those profligate people who trusted in the zeitgeist (made manifest in ready credit) and didn’t worry about such trivial concerns as affordability. They were acting on the same principles as the bankers apparently were, if this immortal quote from Citibank CEO Chuck Prince, uttered at the height of the bubble, is any indication: “When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you’ve got to get up and dance. We’re still dancing.” If the credit is out there, you’re a fool not to take it, even if you know the whole thing is unsustainable. (Some of Ponzi schemer BernieMadoff’s clients apparently had this view as well.) Of course, no one is taking Prince’s compensation from the bubble years back since he was fired, whereas the people who danced to the music by buying overpriced, oversized houses now have to give them back to the banks.

Anyway, a Keynesian stimulus requires getting people—anyone, prudent or not—to spend, even if they don’t “deserve” to. The need to overcome that ideological obstacle requires a strenuous effort to remove moral debate from economic policy considerations. This column by the FT’s Martin Wolf is an excellent example. The most important lesson from Keynes, he argues, is

that one should not treat the economy as a morality tale. In the 1930s, two opposing ideological visions were on offer: the Austrian; and the socialist. The Austrians – Ludwig von Mises and Friedrich von Hayek – argued that a purging of the excesses of the 1920s was required. Socialists argued that socialism needed to replace failed capitalism, outright. These views were grounded in alternative secular religions: the former in the view that individual self-seeking behaviour guaranteed a stable economic order; the latter in the idea that the identical motivation could lead only to exploitation, instability and crisis.
Keynes’s genius – a very English one – was to insist we should approach an economic system not as a morality play but as a technical challenge. He wished to preserve as much liberty as possible, while recognising that the minimum state was unacceptable to a democratic society with an urbanised economy. He wished to preserve a market economy, without believing that laisser faire makes everything for the best in the best of all possible worlds.

But the ideological impediment is persistent, warranting political compromise that tends to reinforce the skepticism.Paul Krugman has written a series of posts about the stimulus possibly being too small:

I see the following scenario: a weak stimulus plan, perhaps even weaker than what we’re talking about now, is crafted to win those extra GOP votes. The plan limits the rise in unemployment, but things are still pretty bad, with the rate peaking at something like 9 percent and coming down only slowly. And then Mitch McConnell says “See, government spending doesn’t work.”

Tyler Cowen makes precisely that case in advance, in economic terms: He argues that

Recovery requires that zombie banks behave like real banks, that risk premia are properly priced, and that the economy undergoes its sectoral shifts toward whatever will replace construction and finance and debt-driven consumption. Fiscal policy won’t do much toward these ends and in fact a temporarily successful stimulus might hinder these long-run adjustments.

Perhaps the ideological conundrum comes down to this: when individuals and firms spend recklessly, this constitutes their freedom (even when the need to spend feels like a compulsion); when governments do the same, this proves they are dispensable (even when government credit is universally acknowledged as necessary to maintain the economic system as we know it). How can we resent and discourage the systemic incentives to fiscal recklessness at the individual level by licensing the government to be reckless in our stead?

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