Stability is the perennial issue in macroeconomics. The economist’s judgment about the stability of the market economy stems from what Joseph Schumpeter called the “pre-analytic vision.” To illustrate the point, Schumpeter specifically used John Maynard Keynes and his pre-analytic vision: Markets are inherently unstable; the government is the stabilizer. This belief, or vision, was held by Keynes years before he published his General Theory in 1936.
The most fundamental criticism of Keynesian economics has been offered by those who embrace the opposite vision: markets are inherently stable; the government is the destabilizer. This was the view of Ludwig von Mises and F. A. Hayek. The evidence of more than a half-century of failed “stabilization policy” strongly supports the Mises-Hayek view. The Keynesians can persist only by arguing that particular countercyclical measures were too weak or implemented too late. Underlying the whole debate, however, is a fundamental and enduring conflict of visions—to use the title concept of Thomas Sowell’s 1987 book.
Writing for the New York Times (Week in Review, August 22, 1999), Louis Uchitelle asks, “Who You Gonna Call After the Next Bust?” His answer—and those of the authorities on whom he relies—are Keynesian in the most fundamental sense. Note the vision-bound assessment of Robert Pollin (University of Massachusetts): “[Markets] can’t cure themselves. We will have to acknowledge that we need government for that. It’s the stabilizer.” And note that Princeton’s Alan Blinder imputes the Keynesian vision to the public: “In the event of a recession, people turn to Government en masse.”
Though there is dispute at the most fundamental level, there can be agreement about the likely course of the economy in the months or years ahead. According to Uchitelle, “the eight-year expansion walks on precarious legs, and when it collapses, getting the American economy back on its feet could be surprisingly hard and painful.” No doubt. But why, specifically, do we say the legs are precarious? And who, exactly, is supposed to be surprised that recovery will be hard and painful?
Uchitelle writes that “The strengths of this expansion are potentially destructive.” (Read: Strengths are weaknesses; the market is inherently unstable.) He sees precariousness in the fact that “the current expansion is fueled by private-sector debt.” Fueled? The Keynesian notion that the government can “fuel” the economy (“goose” the economy would be more apt) by deliberately spending more than it taxes has been uncritically transplanted to the private sector: “It is deficit spending that stimulates an economy, whether it comes from the private or public sectors.” Particularly troublesome, according to Uchitelle, is the prospect that the private-sector stimulant will turn into a public-sector handicap when the bubble bursts. The government will then have to resort to deficit finance to stimulate an already debt-wracked private sector. It is as if the government “were starting a one-mile race from 100 yards behind the starting line.”
Economists who understand the market’s self-stabilizing properties find no special significance in private-sector debt. It doesn’t fuel; it doesn’t stimulate; it doesn’t signify precariousness. Private-sector debt is simply the sum total of the indebtedness of many business firms and individual entrepreneurs. Most have borrowed on the basis of sound judgment and a healthy grasp of their particular economic circumstances. The profits they earn will put them in command of even more resources in the months and years ahead. Some, though, have borrowed on the basis of faulty judgment. They will incur losses and will find themselves in command of fewer resources. This is the nature of the market process; this is the system of profit and loss.
Sign of a Problem
Exonerating private-sector debt per se does not mean that this debt is never a symptom of a problem. But what is the underlying problem? What accounts for the increased level of indebtedness noted by Uchitelle? Is it a credit expansion engineered by the central bank? Is it banking legislation that has encouraged financial institutions to take undue risks while the FDIC continues to provide deposit insurance at subsidized rates? Is it the too-big-to-fail doctrine that has guided regulators in dealing with overextended financial institutions?
It is, of course, all of the above. Centrally orchestrated credit expansion is the cause of boom and bust as spelled out by Mises and Hayek. Externalizing risks and subsidizing risk-taking behavior is another way of fostering an unsustainable boom. And the standard classical case for the system of profit and loss does not fully apply to a system of profit and too-big-to-fail. To recognize these aspects of our mixed economy is to understand that it is because of government policy that the private sector “walks on precarious legs.”
Though not noted by Uchitelle, a clear indicator of “precariousness” is the market’s perverse reaction to seemingly good economic news. Nowadays, when the unemployment rate goes down, speculators turn bearish. Why so? Isn’t lower unemployment a good thing? One view has it that the current unemployment rate (about 4.2 percent) is unsustainable, because it is significantly below the so-called natural rate of unemployment (generally believed to be 5 to 6 percent). The alternative view is that the natural rate itself has fallen.
In an unregulated market economy, the question of which view is correct would be an idle one. But if a central bank is in charge of stabilizing the economy, the question takes on critical significance. Which view does the central bank think is correct? And what are the policy implications? With each movement of the unemployment rate, speculators reform their expectations about what the Fed is likely to do and when it is likely to do it. A central bank trying to manipulate the market while the market tries to anticipate and hedge against the central bank’s actions is not a recipe for macroeconomic stability.
So, who you gonna call after the next bust? If government is the destabilizer, it makes little sense to turn to that same government for stabilization. But the Keynesian economists are sure to make that very call, and the government is sure to respond. Recovery will be hard and painful. Who, though, will be surprised? Not the students of Mises and Hayek.
According to Pollin, acknowledging that we need government to provide stability “will open up a broader debate about what government should do.” Uchitelle has some ideas of his own here. The Federal Reserve, he argues, has had primary responsibility for stabilizing the economy over the past 20 years. It lowers interest rates when the economy begins to falter and encourages the private sector to take on more debt. Now, with private-sector debt at worrisome levels, we need to shift the emphasis from monetary policy to fiscal policy. Uchitelle sees room for old-line Keynesian programs: “More government spending on housing, public works, education and income subsidies seems likely to accompany the next recession.”
Students of Mises and Hayek would opt for decentralizing the monetary system rather than calling on the central fiscal authority to aid and abet the central monetary authority. But no. Suddenly, it’s 1936 again. Keynesian-ism is back—and in its rawest form.