Tuesday, February 10, 2009

Flaxen Cords

At times during the Presidential campaign, I would trade videos of Ron Paul with a friend of mine. We would discuss how we found ourselves agreeing with his ideas, and actually being convinced by him. Then, just as we were about to be seduced, one of us would remind the other: "just remember that his ideas would wreck the economy."

This was easier for my friend and me to remember: we both took a lot of economics in college. Unfortunately, most of the media are a little more easily duped. There was a particular question asked time and time again in the presidential debates: because of the economic crisis, you obviously won't have money for all of your campaign agenda. What will you sacrifice?" This should have set any student of macroeconomics to yelling at the screen. Governments shouldn't spend less during recessions, they should spend more, as they are the only entity with enough market power to prop up demand and encourage consumer spending.

Since I am concerned that you, dear readers, do not fall into the trap of shoddy economic thinking, I want to introduce you to the seductive lie of Austrian economics and debunk it in a safe place before it does any more damage. To do that, I will enlist the help of a friend: Nobel-Prize winning economist Paul Krugman. Krugman indicts the idea "that slumps are the price we pay for booms, that the suffering the economy experiences during a recession is a necessary punishment for the excesses of the previous expansion."

The hangover theory is perversely seductive—not because it offers an easy way out, but because it doesn't. It turns the wiggles on our charts into a morality play, a tale of hubris and downfall. And it offers adherents the special pleasure of dispensing painful advice with a clear conscience, secure in the belief that they are not heartless but merely practicing tough love.

Powerful as these seductions may be, they must be resisted—for the hangover theory is disastrously wrongheaded. Recessions are not necessary consequences of booms. They can and should be fought, not with austerity but with liberality—with policies that encourage people to spend more, not less. Nor is this merely an academic argument: The hangover theory can do real harm. Liquidationist views played an important role in the spread of the Great Depression—with Austrian theorists such as Friedrich von Hayek and Joseph Schumpeter strenuously arguing, in the very depths of that depression, against any attempt to restore "sham" prosperity by expanding credit and the money supply. And these same views are doing their bit to inhibit recovery in the world's depressed economies at this very moment.

Krugman wrote this article over ten years ago in talking about the Asian recession, but it is every bit as relevant today as it was then. I strongly encourage you to read the whole article, but this takeaway quote is really food for thought:

One often hears that Japan is adrift because its politicians refuse to make hard choices, to take on vested interests. The truth is that the Japanese have been remarkably willing to make hard choices, such as raising taxes sharply in 1997. Indeed, they are in trouble partly because they insist on making hard choices, when what the economy really needs is to take the easy way out. The Great Depression happened largely because policy-makers imagined that austerity was the way to fight a recession; the not-so-great depression that has enveloped much of Asia has been worsened by the same instinct.

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