Nothing Was Delivered

I recently got into an argument on Facebook with a friend of mine about monetary policy. Since that forum is really more conducive to funny memes and reports of cute things one’s kids said/did/broke that morning, I thought I would take the discussion out to the internet at large, where anyone and everyone can stop by to tell us where we’re full of shit. 

Economic theory isn’t really my strong suit. I’m more of a song and dance man. Still, while I respect my friend’s opinion about monetary policy, something about it doesn’t ring true. 

My buddy, you see, is a Hard Money die hard. He believes that no matter their intentions, just about any attempt by the government or central bank to kick start the economy will only make matters worse in the long run. In his words:

Basically I believe in Austrian School and Chris believes in Keynes. Everyone talks about austerity being a bad thing. It’s not. People tend to forget that government cannot create money in a real sense, it can only take it. If you count on the government to put people to work you will eventually have a currency collapse unless it’s paid for. The reason the Depression lasted as long as it did WAS because of the actions of Hoover and Roosevelt. Had Hoover done nothing the Depression would have been over in two years. 

The market is a self sustaining organism. The 1920 Crash happened and the resulting Depression was over in 16 months. Reason was Harding did absolutely nothing EXCEPT for imposing import tariffs which made domestic goods more attractive.

This strikes me as comparing apples and oranges. First off, lets take a look at this chart: 

This shows US GDP in the interwar period. Look at the recession of 1920 compared to what followed in 1929. We’re talking about events of vastly different scopes. The causes were different, the politics were different, and the scales were different. That big dip at the end of the roaring 20’s is really an historical anomaly.

I’m not an expert in the Great Depression, but the idea that a more laissez-fair approach by the Hoover Administration  would have ended the Depression within 2 years (FDR didn’t come into office until 3 1/2 years into the Depression) doesn’t make sense. If you look at the timeline, the economy was basically in freefall until the New Deal began, when we finally started seeing positive growth. 

It seems to me that FDR did the best that he could. The length of the Great Depression was a function of the hole that we found ourselves in after nearly 4 years of fumbling around in the dark. I can’t imagine that growth could have been significantly steeper had Roosevelt come into office and sat on his hands. But I’m not really the guy to re-argue the Great Depression. This whole thing started with us talking about what could be done here, and now.

Obviously something’s not working. Income inequality is at an all time high. Official unemployment is struggling to stay at 8%. For better or worse, the government body we have tasked with fixing the economy is not Congress or the Presidency, but the Federal Reserve. The Fed has basically 2 options in front of them. Tightening up the monetary supply by raising interest rates, or printing money and dropping it from a helicopter.  Instead, for the past couple of years, they’ve opted for neither. 

My friend continues: 

But all printing money is going to do is to raise prices. We need DEFLATION, not Inflation. The person on a fixed income would be more than happy to see prices go down.

Lets just stipulate that any monetary policy has winners and losers. The goal of government policy should be to increase the welfare of the overall population. Imagine that we were in a situation of deflation today. (Current inflation is so low that this isn’t very hard.) If prices started falling, this could be good in the short term for some people. Folks on a fixed income would, for instance, benefit, by being able to stretch their dollars farther. But over all the economy cannot grow with deflation. Falling prices would mean retailers, wholesalers, manufacturers, and those in the service economy would all find themselves pulling in less income for the same amount of work. They would be forced to lay off employees. The average spending power of the economy dips for every lay off. With fewer and more frugal customers, retailers will find themselves with unsold goods and service providers with unutilized services. In order to compete, they will likely have to resort to a combination of lower prices and lay offs, and the cycle continues. This is a terrible hole to have to dig out of. 

The other option is to pump more money into the economy. You need to remember that modest inflation is not generally desirable in and of itself (though it could be useful to many underwater home owners after a real estate crash such as the one we had in 2007 , as mortgages are set in real dollars). Inflation is a natural outcome of a rebounding economy. As unemployment starts going down, the newly flush are going to want to splurge a bit. They have probably been in a bad financial situation for a while, and as soon as they start getting steady checks again, you’ll see them looking to move out of the room at they’re relatives house they’ve been staying at. They’ll need to decorate that new apartment, and will have to go out and buy furnishings. It will be time for the car repairs they’ve been putting off. Maybe they can finally get married to their sweetheart and hire a caterer, book a hall, and register at Pier One. All of these things will, in aggregate, boost the economy. The retailers, manufactures, and caterers involved will all eventually need to hire on people to fill the demand. But in the short term, we’ll see prices rise. The temptation for the Fed will be to put on the breaks by raising interest rates, but that would only cause another slump. 

“What about hyperinflation?!?!”, you ask.  “Weimar Republic? Zimbabwe?” Okay, calm down. Yes, we can all agree that hyperinflation is very bad. But when faced with the very real problem of structural unemployment right now, and the phantom problem of maybe, someday, having runaway inflation, isn’t it best to worry about the problem at hand? People are suffering today because they can’t find work, can’t pay their bills. The reason for that is there’s not enough money going around. Meanwhile, inflation is at historical lows. We should be using every tool in the book to stimulate demand. Half measures will not fix the problem.