Macroeconomics 121
The last post summarized Monetary Policy. Our modern macroeconomic system is a lot to process without commentary. Now that you know the basics, we can get into philosophy.
There are a bunch of economic schools of thought—I’m going to focus on Keynesian vs Austrian.
It’s unnecessarily confusing that a liberal politician and a liberal economist are diametrically opposed, foes. A liberal politician is on the left, leaning progressive/socialist, whereas a liberal economist is on the right, leaning free market/capitalist. Who made these rules? I digress.
If you have paid attention to my disdain for statistics and averages, and treating individual people like they are data points, then you can safely conclude I am not a fan of macroeconomic policy and tools. It’s necessary, but it should be limited.
I value individual human action, its unpredictability and creativity; goodness, even. When provided with good information, I trust people to make good decisions. Good information is key in the process of aligning individual and societal interests, and I believe you can solve most negative externalities through education—a country with a good education system will need to resort to force (coercion) far less often. It’s the same reason why the most successful sports teams, long-term, have good coaches and good captains—good leadership! The leaders are there to educate and inspire, to align the interests of the team members (citizens & consumers) with the team itself (the country & economy).
There’s this thing called the Business Cycle, aka the Boom and Bust Cycle.
The basic idea is the economy’s output, GDP, is constantly overcorrecting. We have wild swings, booms and busts, with the appearance of stability in between. The ideal is a constant, sustainable rate of growth, but reality is a stretch of growth followed by a stretch of recession; two lunges forward, only to stumble backward.
Why?
This rap battle presents two arguments and has my full endorsement. Solid economics, solid rhymes.
Keynesianism blames our steep crashes as the result of human irrationality, aka “animal spirits”. Things like herd mentality. He focuses on the “Paradox of Thrift”, which I mentioned early on in this series, as a reason why the inflation numbers today are nearing 0%. Closer to deflation than hyperinflation, despite our trillions of dollars of recent government spending. I told you, didn’t I?
So, Keynes says the masses are the problem. An inexplicable dip as markets close on a Friday afternoon, and investors are going to overthink it all weekend and, due to cognitive biases such as loss aversion, many decide to sell their stocks on Monday, triggering a stampede. Study any of the major stock market crashes, and you’ll see similar patterns.
Keynes’ solution? Central planning and macroeconomic tools. Allow experts to make decisions, not the uneducated masses. Specifically, the government should have more control over the economy, and the general populace should have less. Top down.
I gotta say, the more time I spend in leadership, the more I sympathize with Keynes. Haley Joel Osment sees dead people? I see irrational people.
So am I Keynesian? Nah. When my senses tell me other people are irrational and I’m special, I don’t trust my senses. Admiral Ackbar senses a trap? I sense sensing a trap is a trap.
Keynes says when people stop spending, leading to a decrease in consumption and GDP and worsening the “crash”, then the solution is to increase government spending and make loanable funds more easily accessible. Since people fail to act the way they *should*, the government picks up the slack and runs intentional deficits in bad times. We can figure out how to balance the budget during good times.
World War II is often credited with bringing the U.S. out of the Great Depression, which is both shallow and perverse. Frederic Bastiat (my favorite) would call this the “broken window fallacy”, pointing out that destruction is not profit. A shoemaker who spends two francs repairing a broken window is back where he started, neutral, although the window repairman is grateful for the support. It would have been better if the shoemaker could have spent that money on new shoes, or anything that results in a net positive. If someone goes down the street throwing rocks through windows, is that good or bad for the economy? If someone invents an unbreakable window, is that good or bad for the economy? It’s easy to say spending is good for the economy and saving is bad, but it doesn’t take much thought to see through the superficiality. Is it better to crank out ships that are destined to be sunk by submarines, or direct that capital elsewhere? People are dying by the millions, cities are being leveled, and your conclusion is this boosted the economy? Perverse.
Keynesianism became nearly universal in the quarter century after WWII, then took a hit when questions arose around the long-run efficacy of macroeconomic policies, specifically concerning The Phillips Curve. The curve notes a historical correlation between high inflation and low unemployment, so the conclusion was the government could manipulate unemployment rates by manipulating inflation rates. The model broke down in the 1970’s, when there were periods of sustained high unemployment and high inflation. Stagflation.
Now, Keynesianism is back in the driver’s seat. But what’s the alternative?
Austrians economists blame our unsustainable economic booms on government intervention. The government, using the Federal Reserve, manipulates interest rates to be artificially low, which results in mal-investment. Mal-investment is, quite simply, bad investments. People respond to incentives, and if the incentives are bad, it results in more bad actions. [Take, for example, hospitals getting paid 20% more by the government for treating patients designated as COVID-19. Oof.]
F.A. Hayek is one champion of Austrian economics, and he wrote a book called The Fatal Conceit. The Fatal Conceit is thinking you’re special, more or less. “The idea that man is able to shape the world around him according to his wishes”.
Analyzing our previous recession, Austrians would say the housing market going into 2008 was an economic “bubble”, which is exactly what it sounds like: overinflated prices/valuation which will pop under any pressure. What caused the bubble? Government actions like the Community Reinvestment Act of 1977, in which the government incentivized banks and lending institutions to loan to “under-qualified” segments of the population. Presumably, a lot of people in government thought owning a home was a “right” or part of the American dream. The resulting rules encouraged ignoring economic reality and celebrated home “ownership” at any cost, including economic devastation down the road. If sub-prime borrowers are being given mortgages, it’s going to result in more construction, increased housing prices, and job creation in an industry above equilibrium levels, a ticking time bomb. Eventually, the bubble bursts, and everyone pays the price.
[I moved to Phoenix in 2011, when there were still some visible dystopian effects of the real estate crash. There was a construction project building an exit off the freeway leading to (what was supposed to be) a massive shopping mall and housing development project—all of it had been halted in the middle. Unfinished. It was still untouched when I left Phoenix three years later. Watch The Big Short. The calculations were all wrong because the rules were bad]
What’s the Austrian solution to avoid massive crashes like The Great Recession? Minimize government intervention. Bottom up decision making. The artificially low interest rates create spending and loans that wouldn’t have happened otherwise, and result in economic bubbles, but we never can be sure where the bubbles are or when they are going to burst until they do. This potential lockdown recession isn’t due to a bubble, but it could result in the student loan bubble bursting. When it happens, remember I told you. You had a good run, higher education! [I’m not predicting the end of higher education itself, just our current model]
So if the economy’s output was a railroad track we could build piece by piece, we would want it to slope upward in a straight line year after year, forever, without relying on inflation for growth. Instead, the economy is a roller coaster. Slow builds leading into wild swings, unpredictable turns, and sudden drops. Sometimes you go upside down? And the more interconnected everything becomes, the bigger the roller coaster. [I just got distracted imagining a roller coaster track built for the Titanic]
The Great Depression was catastrophic because of the confluence of several events across several years, starting in 1929. You had Black Tuesday (stock market crash), the Dust Bowl (sustained drought), bank runs (9,000 banks went bankrupt), and the Smoot-Hawley Tariff (would you believe I had the current seniors make a history I.D. card for it back in seventh grade?!). Those things were spread out over several years, and all contributed to deepening and extending the depression. Now? We don’t need a series of unfortunate events, we just need one. That’s the tradeoff to a global economy. There are certainly good aspects, most obviously increased wealth and development and increased incentive to avoid war, but there are also costs. [My movie recommendation this week is Dr Strangelove Or: How I Learned To Stop Worrying And Love The Bomb. Director Stanley Kubrick is a legend, and Dr. Strangelove is a brilliant satire of The Cold War, during The Cold War]
What’s the Austrian solution to the Business Cycle? Minimize government intervention, so people can make decisions without interference. I would add good rules and good education are paramount in order for this system to work. If your country produces people who can’t think for themselves, then of course it’s going to seem like a good idea for experts and central planners to make decisions on their behalf.
To summarize.
Keynesians view the problem in the business cycle as the “bust”, blame irrational behavior for worsening it, and believe the solution to minimizing busts is government intervention, central planners, and, above all else, spending. They would say it’s irrational for people to run to the bank to pull out their money, because the panic is what causes the bad outcome. It’s “irrational” to save money in bad or uncertain economic times, because a decrease in spending makes slowing economies even worse. So, to cover for bad decisions made by these “animal spirits”, the government steps in. After taking the U.S. dollar fully off the gold standard in 1971, Republican President Richard Nixon said “I am now a Keynesian in economics”, and that change has given the federal government much more freedom and power to *attempt to* manipulate the economy. It boils down to a desire to “steer” the economy, using fiscal and monetary policy.
Austrians view the problem in the business cycle as the “boom”, blame government intervention for creating economic bubbles, and believe the solution to minimizing mal-investments is reducing government intervention, above all else. They would say it’s impossible to intervene in one area of the economy without causing unintended consequences in another area, which leads to more bubbles and more government intervention, creating an endless cycle of increasing the role and size of government. Upping government spending and deficits during an economic downturn is the equivalent of waking up with a hangover and deciding the best strategy is to continue drinking. It boils down to a faith in individual human action, and recognizing scientific knowledge (aggregates and mathematical models put together by experts) has become overvalued, while the knowledge of particular place and time (the things you know that no one else knows) is being overlooked.
It should be clear which side I favor, but I do see both sides. I don’t think Macroeconomic tools are inherently bad, but I do think it’s bad to believe they can solve all our economic problems without causing others. I don’t think it’s reasonable to return to the gold standard, but I do think we are abusing fiat currency by racking up debt with reckless abandon. And so on.
We’re here, now, and I’m focusing on finding the best way to move forward. We need good leaders and an educated populace. I’m focused on doing my part, at the micro level. Bottoms up!
