Recessions not only expose the weaknesses of a boom-and-bust economy, but they also expose the weaknesses of economists, and especially “elite” and Federal Reserve System economists. For example, Martin Feldstein of Harvard, President Reagan’s chief economic adviser, has called for the reflating of the housing bubble.
We are aware of Paul Krugman’s semi-weekly New York Times complaints that the Obama administration is not profligate enough in borrowing, printing money, and spending. (Such missives even have earned him a coveted spot on the cover of Newsweek in which he expanded his criticisms of the president’s economic “plan.”)
However, former George W. Bush economic adviser Gregory Mankiw, also of Harvard, has done Krugman and Feldstein one better: he has endorsed the proposals of perhaps the most famous “crank” in history, Silvio Gesell. It was Gesell, a German economist of the late 19th Century who advocated that governments issue money which would officially depreciate via a tax on people who held money instead of spending it quickly.
John Maynard Keynes, in his General Theory, went as far as to call Gesell a “prophet,” and while Mankiw does not bestow such an august label upon Gesell, nonetheless he implicitly endorses this scheme, but relying on the old friend of money-monopolizing governments: inflation. He writes in the April 18 New York Times:
If all of this seems too outlandish (taxing people who hold money), there is a more prosaic way of obtaining negative interest rates: through inflation. Suppose that, looking ahead, the Fed commits itself to producing significant inflation. In this case, while nominal interest rates could remain at zero, real interest rates — interest rates measured in purchasing power — could become negative. If people were confident that they could repay their zero-interest loans in devalued dollars, they would have significant incentive to borrow and spend.
Having the central bank embrace inflation would shock economists and Fed watchers who view price stability as the foremost goal of monetary policy. But there are worse things than inflation. And guess what? We have them today. A little more inflation might be preferable to rising unemployment or a series of fiscal measures that pile on debt bequeathed to future generations.
Keep in mind that Mankiw is a “respected” economist, and is considered to be, relatively speaking, a “free-market economist,” as is Feldstein. Yet, in a time of crisis, Mankiw, Feldstein, and others instinctively turn to inflation as a solution.
As I see it, this latest “mad scientist” scheme exposes a greater weakness in mainstream economics, and that is the lack of a real understanding of how an economy works. It seems ironic, and perhaps arrogant on my part, for me to accuse economists – and prominent ones at that – of being ignorant of economics, but that is what I am doing.
It is not just that economic journals are full of esoteric mathematical models that can be deciphered only by someone with training in math, nor is it just that economists depend upon models that are full of “givens” which are not “given” at all, such as factor prices. The larger problem is that many “prominent” economists cannot explain the real nature of exchange, they do not understand money at all, and they lack a coherent theory on capital.
Most economics textbooks give the standard definitions of money (medium of exchange, store of value, etc.), but fail to understand that money itself is a good used exclusively for exchange and that it, too, is subject to the same laws of economics as other goods. Instead, they tend to see it as a quantity variable that can and should be manipulated by government in order to ensure “sufficient aggregate demand.”
What they don’t see is that manipulating and inflating money creates numerous dislocations within the economy itself, especially in capital markets, driving the fundamentals out of balance and furthering malinvestments. Furthermore, the latest Mankiw scheme would ensure the deterioration of current capital stock and retard future capital investment.
The Austrians, however, have not drunk the Gesell-brand Kool-Aid, and one hopes that their theories of capital development, free markets, and sound money someday will resonate with the public and policy-makers. The alternative is depression and inflation.
