The tortuous times of the past two years when nations have been embroiled in economic crisis has revived an old battle between macroeconomic theories. Huge differences have evolved between political leaders and economists on matters of public policy to deal with the challenges. The root of these philosophical differences lies in the macroeconomic theory of the last century. It is the dilemma of whether free markets create a more prosperous economy or whether government management of an economy is best.
In the 1930s the idea of government managed or planned economies emerged in the classic “General Theory of Employment, Interest and Money” by John Maynard Keynes. This dominated economic theory until the concept of market economics gained favor, championed by the Austrian economist, Friedrich Hayek. His book “The Road to Serfdom” challenged the merit of socialism and the negatives of government intervention in private sector. It argued the merits of free market capitalism and individual liberty. Hayek’s philosophies were embedded in the thinking of other economists and world leaders, namely Milton Friedman and Margaret Thatcher. A young Milton Friedman attended a series of salons on macroeconomic theory run by Hayek at a resort in Switzerland, known as Mont Pelerin. Hayek was awarded the Nobel Prize in 1974 and Milton Friedman followed in 1976.
Now, it seems that Keynesian ways are back as governments overdose on “stimulus packages” (spending like drunken sailors) and endeavor to aggressively manage economies. Too often political leaders neglect to recognize that it was errant public policy that got us into this mess in the first place. Forgotten is the fact that congress aggressively pushed home ownership for all Americans…regardless of their economic status or their ability to pay the mortgage when the “teaser rate” term ended. Washington encouraged families to use credit (mortgages) to purchase homes they could not afford through low interest rates, low down payments and flooded the mortgage markets with capital through Freddie Mac and Fannie Mae. Keynes never imagined that political leaders could be so reckless and unwise in the economic policies that they pursued.
This caused an “asset bubble” as home prices surged and our nation overbuilt the stock of homes to an excessive level. Homeowners began to use their new home equity as an ATM, tapping it for cash to buy boats, RVs and upgrade their homes. There was an enormous growth in consumer spending and the economy was fueled by the expansion of credit. Certainly Wall Street got on board with this by the expansion of the securitization of mortgage portfolios and the creation of new derivative instruments. It started with bad public policy and was amplified by financial engineering.
The credit “binge”, engendered by bad public policy, caused the US economy to grow at a rate above its natural rate (without the meddling of government in the economy). Oddly, now political leaders are attempting to get the economy going by encouraging consumers to borrow and spend (cash-for-clunkers, mortgage incentive programs, etc.) and, of course, the government is a huge borrower and spender itself. It seems that we are trying to get out of the recession by doing more of what put us into it in the first place.
What must follow is a period of de-leveraging, where the economy will grow below its natural rate until balance sheets are repaired. Without the Keynesian public policy initiatives, the economy would not have become supercharged in the 2002-2007 period, the credit crisis would not have occurred and the nation’s growth during the next decade would be higher and more stable. You will never hear this discussed in our congressional hearings…they will be busy “bashing” business leaders in the private sector. Hayek would say “Just leave it alone and the economy will do fine”. Keynes would say “Intervention by government is essential to avoid disasters”. The “Achilles’ heal” in Keynes’s thinking was the assumption of wise governance.
The pejorative effect of errant public policy during challenging times can be huge. Regardless of who is right, it would benefit us all if members of congress would be required to pass an Economics 101 test.
In the 1930s the idea of government managed or planned economies emerged in the classic “General Theory of Employment, Interest and Money” by John Maynard Keynes. This dominated economic theory until the concept of market economics gained favor, championed by the Austrian economist, Friedrich Hayek. His book “The Road to Serfdom” challenged the merit of socialism and the negatives of government intervention in private sector. It argued the merits of free market capitalism and individual liberty. Hayek’s philosophies were embedded in the thinking of other economists and world leaders, namely Milton Friedman and Margaret Thatcher. A young Milton Friedman attended a series of salons on macroeconomic theory run by Hayek at a resort in Switzerland, known as Mont Pelerin. Hayek was awarded the Nobel Prize in 1974 and Milton Friedman followed in 1976.
Now, it seems that Keynesian ways are back as governments overdose on “stimulus packages” (spending like drunken sailors) and endeavor to aggressively manage economies. Too often political leaders neglect to recognize that it was errant public policy that got us into this mess in the first place. Forgotten is the fact that congress aggressively pushed home ownership for all Americans…regardless of their economic status or their ability to pay the mortgage when the “teaser rate” term ended. Washington encouraged families to use credit (mortgages) to purchase homes they could not afford through low interest rates, low down payments and flooded the mortgage markets with capital through Freddie Mac and Fannie Mae. Keynes never imagined that political leaders could be so reckless and unwise in the economic policies that they pursued.
This caused an “asset bubble” as home prices surged and our nation overbuilt the stock of homes to an excessive level. Homeowners began to use their new home equity as an ATM, tapping it for cash to buy boats, RVs and upgrade their homes. There was an enormous growth in consumer spending and the economy was fueled by the expansion of credit. Certainly Wall Street got on board with this by the expansion of the securitization of mortgage portfolios and the creation of new derivative instruments. It started with bad public policy and was amplified by financial engineering.
The credit “binge”, engendered by bad public policy, caused the US economy to grow at a rate above its natural rate (without the meddling of government in the economy). Oddly, now political leaders are attempting to get the economy going by encouraging consumers to borrow and spend (cash-for-clunkers, mortgage incentive programs, etc.) and, of course, the government is a huge borrower and spender itself. It seems that we are trying to get out of the recession by doing more of what put us into it in the first place.
What must follow is a period of de-leveraging, where the economy will grow below its natural rate until balance sheets are repaired. Without the Keynesian public policy initiatives, the economy would not have become supercharged in the 2002-2007 period, the credit crisis would not have occurred and the nation’s growth during the next decade would be higher and more stable. You will never hear this discussed in our congressional hearings…they will be busy “bashing” business leaders in the private sector. Hayek would say “Just leave it alone and the economy will do fine”. Keynes would say “Intervention by government is essential to avoid disasters”. The “Achilles’ heal” in Keynes’s thinking was the assumption of wise governance.
The pejorative effect of errant public policy during challenging times can be huge. Regardless of who is right, it would benefit us all if members of congress would be required to pass an Economics 101 test.
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