The Obama administration has spent its time pursuing a Keynesian solution to fix the ailing American economy. Day after day, the administration has lamented the absence of demand in the economy. Boosting demand will rapidly grow the economy, they insist.
As readers know, I reject this argument. Keynesianism has been tried again and again. It has come up short repeatedly. It never delivers. But politicians love it because it gives them a reason to use fiscal policy in hopes of assisting an ailing economy.
Ludwig von Mises once wrote that the genius of Lord Keynes was his justification for what politicians wanted to do anyway. Keynes thought during economic downturns, government should step in and pump money into the economy to boost demand. Insufficient demand, Keynesians believe, is what causes recessions, market failures and difficulties with the business cycle.
The Raison d’être for this is the (misguided) belief that there is an absence of money/spending (demand) in the economy. Who has the money to spend when the economy was in the toilet? Government does.
Classical economists warned such attempts would create a boom and bust environment. They feared government interference in the market would screw up the business cycle; pumping money into the economy would also inflate the money supply and create future problems down the road.
Mises condemned politicians’ tinkering inclinations, saying they would sacrifice the long-term health/stability of the national economy in order to win the next election. He was especially concerned about the unintended consequences that came from priming the pump by expanding credit. He called credit expansion/inflation the government’s “first principle of economic policy.”
What should government do, instead? Keynesians ask. Government can’t just stand by and let people suffer. This thinking stems from a fundamental rejection of classical economics, primarily the contributions from 18th century Frenchman Jean Baptist-Say.
Say’s writings focused on the supply-side of the economy. He concluded that the production of goods opens up demand for other goods. In other words, the ability to demand goods comes from one’s own production. Say’s law, as it came to be called, has been popularly summarized as follows: “supply creates its own demand (a phrase first used by James Mill).”
While supply always will equal demand, demand will not always equal supply. Think about it: when you go shopping, you don’t spend all your money at once. You save some money for future needs.
Money, Say reminded us, is not what allows people to buy things. Money is simply a reflection of one’s productive assets. It’s a mechanism that reflects consumers’ purchasing power.
Wealth was derived from production, not consumption, classical economists maintained. Lord Keynes emerged in the 1930s and turned that notion upside down. The Keynesians said that consumption (demand) was what needed be boosted in order to create an affluent society.
If insufficient demand causes economic downturns, how does insufficient demand come about? They wondered. Insufficient demand is a result of excess supply, a result that is derived from classical economics. A glut (concentration) of goods is left unsold because consumers lack the demand to buy them.
Classical economists categorically reject this assertion. There is no absolute overproduction of goods. Mises claimed that there may be a relative overproduction of some good in the short term, but this would not take over/influence/derail all sectors of the economy.
In other words, Mises said there would not be a general overproduction of all goods.
He used an example of relative overproduction in a department store to illustrate his point. The store sold slacks and shirts and, at a particular moment, might have too many slacks and not enough shirts. How do you fix this? Simply raise the price of slacks, making the price of shirts more competitive
That didn’t mollify Keynesians, who still that excessive supply was the chief obstacle in the business cycle. Excessive supply also results from “the rich” hoarding supply. Therefore, Keynesians promote fiscal policies designed to “fix” the problem. Government must step in and redistribute wealth (through a progressive tax system) from the affluent to the poor and middle classes, ensuring that demand trickles down to the least among us.
No. No. No. Classical economists say. Money is not hoarded. The rich invest their excess supply in the market. They also put their money in banks, primarily in checking accounts. If that money is invested or in a bank, this excess supply will be used to lend others that “excess” supply. This will straighten out the supply/demand equilibrium.
So if insufficient demand doesn’t cause a recession, what does? Classical economists say a recession is a result of monetary failure, i.e. there is too much/too little money in the economy.
Throughout the 20th century, these ideas shaped what became known as the Monetarist tradition. Milton Friedman became the intellectual godfather of this movement. Friedman argued that the key to economic stability was controlling the money supply. Here are a few of his general policy prescriptions:
The theoretical foundation is the Quantity Theory of Money.
The economy is inherently stable. Markets work well when left to themselves. Government intervention can often times destabilize things more than they help. Laissez faire is often the best advice.
The Fed should be bound to fixed rules in conducting monetary policy. They should not have discretion in conducting policy because they could make the economy worse off.
Fiscal Policy is often bad policy. A small role for government is good.
2oth century Christian apologist G.K. Chesterton once famously remarked: “Christianity has not been tried and found wanting; it has been found difficult and not tried.” The same can be said for classical economics and the monetarist tradition.
Politicians, by their very nature, are averse to the political implications of the laissez-faire policies promoted by classical economists. The voters will kick us out if the economy is in the tank and they don’t see us doing anything, politicians think. This idea has facilitated the Keynesian revolution over the last eighty years. It has also kept the economy in the doldrums since the 2008 financial crash.