Stocks just set a new record for the longest “bull market” in history. If you’re an optimist, this is a reason to celebrate the relatively high level of economic freedom in the United States.
If you’re a pessimist, you might appreciate that there’s more economic liberty in America than most other places, but you still worry whether easy-money policies from the Fed have created a bubble in financial markets.
And if you’re fair, you admit that some of Trump’s policies are helping the economy and some are hurting the economy. Which was my message in this recent interview.
Regardless, this discussion got me thinking of how best to explain the importance of various economic policies. Regular readers know I’m a huge fan of both the Fraser Institute’s Economic Freedom of the World and the Heritage Foundation’s Index of Economic Freedom.
At the risk of oversimplifying, both publications measure economic freedom by looking at a combination of fiscal policy, regulatory policy, trade policy, monetary policy, and quality of governance (encompassing factors such as the legal system and property rights).
Generally speaking, the various policies are equally weighted. Which, based on a lot of research, is correct. But I wonder if the various policies are equal in different ways. I sometimes use a simple analogy in speeches, equating economic policy with the soundness of a house.
- The quality of governance is akin to the foundation, because just as a very nice house won’t last long if built on a shaky foundation, good policies won’t generate much prosperity if the legal system is corrupt and property rights aren’t protected.
- Monetary policy is akin to the framework of the house because it is also systemically important. Most recessions (and the false booms that precede downturns) are caused by misguided central bank tinkering.
- Finally, as shown in my amateur drawing, trade policy, regulatory policy, and fiscal policy are the floors of the house. They determine the livability of the house, whereas monetary policy and quality of governance determine the structural soundness of the house.
To elaborate on this analogy, consider what I wrote a few days ago about Denmark. That house has a strong foundation and a solid framework, but the floor for fiscal policy is a total mess. Since I focus mostly on public finance, I get very agitated about that floor of the house. But as an economist, I nonetheless admit it’s still a nice place to live.
Conversely, Lebanon has one the best floors for fiscal policy, but the foundation is quicksand and the regulatory floor is a wreck. So that may not be an ideal place to live (notwithstanding compensating factors).
Anyhow, I’m looking for feedback. When I first proposed my Golden Rule, it was wordy and clunky. I got some great suggestions and eventually produced a much better version. I’d like to do the same for overall economic policy.