Posner Gets It Wrong on Macroeconomics
Recession is the falling-down part. Depression is staying down. Normally, the recuperative powers of a market-oriented economy are sufficient that the falling-down part is immediately followed by a rising-back-up part. But, that's not happening now, and that didn't happen during the 1930s.
Richard A. Posner, writing in the New Republic, says that there's probably little we can do about our depression. While he identifies some mistakes of the current and prior administrations, the fiscal imbalances of the federal government are so enormous, he says, there is no way out.
For those who prefer a book length immersion into hopelessness, there is Posner's The Crisis of Capitalist Democracy (2010).
Richard A. Posner is perhaps the foremost legal scholar of our time. In particular, his Economic Analysis of Law (1973) is a classic, and clearly influenced by Hayek. Because of his intellectual rigor and independence of thought, his comments on the financial collapse and the subsequent economic disaster were received with some anticipation. That he is so pessimistic leaves people either disappointed or wondering whether there actually are some intractable problems associated with capitalism.
Among the problems of contemporary macroeconomics is its focus on the short run, using Keynesian methodology. In this approach to macroeconomics, it is presumed that the economy is near enough to equilibrium that any changes in fiscal or monetary policy can, by manipulating aggregate demand, have discernible impacts on production, employment, and prices.
If, let's say, the economy is fundamentally sound, and a shock occurs — such as happened on September 11, 2001 — threatening to disrupt people in the course of their plans, then, say the Keynesians, the government might be able to restore the former equilibrium by certain policies. In addition, projecting confidence — though difficult to measure — could also prove effective.
In the Keynesian view, investors and others in the private sector are beset by "animal spirits," prone to overreacting, even panicking, to the flow of information; and, because an economy involves so many interrelationships, none of us is safe from the overreactions of others. In contrast to the psychologically unstable private sector, Keynesians see the government as even-tempered and committed to the general welfare. Thus, government is able to resist the tenor of the times, and intervene with discretion, offsetting the fickleness of the private sector.
Economists of the Keynesian view tend to be progressive in thinking that the government consists of a different class of people from those in the general population. In a former time, they might have believed in the divine right of kings and hereditary monarchy. Another mechanism for the continued rule by the right people is self-perpetuating governing boards, on the basis that the higher class of people can recognize each other from amongst the masses.
In democratic systems, a different trick is involved. It is a belief that the members of the natural aristocracy can gain power through the democratic process, for example, by using a combination of eloquence and duplicity in their speeches. In general, the more removed government officials are from the people, the more intelligent and public minded they are supposed to be. At the top would be the unelected, appointed officials of government. Not very trustworthy would be those officials who are directly elected from the people from relatively small districts.
So, the Keynesian view is that the government has the intelligence and temperament to keep an economy functioning at a high rate of performance, in spite of the inclination of the private sector to overreact to the flow of information. To demonstrate this ability of the government, college sophomores are taught the sacred symbols and rituals of belief in government, including the hocus pocus of "marginal propensity to consume," "the multiplier," and "exogenous demand." And, for those choosing to join the priesthood of this religion, the Keynesian cross is developed into the ISLM diagram.
But, woe unto all belief in false gods, no matter the sacrificing of the children to the Magog of National Debt. It utterly fails.
The Natural Recuperative Power of a Market Economy
So, what constitutes the normal recuperative power of a market-oriented economy? There was a time when the tendency of market-oriented economies to feature a business cycle was the focus of what we now call macroeconomics. Ludwig von Mises, in his classic The Theory of Money and Credit (1912), made systematic our profession's thinking about this subject. And, for many years, it was the standard textbook. Knut Wicksell (Interest and Prices (1898)) and the Swedish school contributed to this line of investigation, as did Hayek in Monetary Theory and the Trade Cycle (1933).
As to why there are times of speculative excess, the argument is that an expansion of money and credit allows the interest rate to fall below the level consistent with sustainable economic growth, engendering not only an increase in investment, but various concrete forms of investment — called malinvestments — that cannot be easily undone upon the discovery that the economy had been involved in a speculative orgy.
As to how such "booms" can get underway, any number of reasons can be cited, such as private banks pyramiding money and credit upon the monetary base, or governments increasing the monetary base. If distinguishing speculative booms from sustainable investment were easy, either the government or the private sector, separately or together, might be able to prevent speculative booms. As to whether distinguishing speculative booms from sustainable investment is even possible in real time, and how speculative booms might be mitigated, such as by restricting the growth of money and credit, would be a crucial part of monetary theory and policy. But, with the Keynesian revolution in macroeconomics, such a thing wouldn't even matter, because it is presumed that the government can always undue any problem that ever develops.
Now, looking at the "bust" that follows the "boom," as the economy falls into recession, at some point, investors perceive a profit opportunity in hiring labor and other factors of production, because of their low cost; and, also because of the low rate of interest. Because of these conditions, investors anticipate selling the production they finance in the future at a profit. This is the recuperative power of a market-oriented economy, and why most recessions are immediately followed by recovery. Indeed, this is why the vigor of the recovery is usually correlated with the depth to which the economy fell during the recession, so the recovery is stronger when this is most needed.
So, why isn't a strong recovery happening now, and why didn't a strong recovery happen during the 1930s? Why is money "staying on the sidelines"? Why is cash building up in corporate treasuries, or staying or moving offshore, or being exchanged for gold now (and why was gold confiscated during the 1930s)?
There are two very important reasons why a strong recovery isn't happening. Number one, the government has been propping up wages and prices; and number two, the government has been threatening profits both rhetorically and through its grave fiscal imbalance.
The old-time religion of Austrian economics is for malinvestments to be quickly liquidated. Asset values need to be written down, if necessary, through bankruptcy, so that they can then be profitably reemployed. The government has done just the opposite. It has engaged, instead, in bailouts of corporations and property owners, prolonging and exacerbating the consequences of the malinvestments made during the boom years. The government also intervened and is intervening in the normal market process of repricing factors of production so as to induce reemployment.
During the 1930s, it was the Reconstruction Finance Corporation, the National Recovery Act, the Wagner Act, farm programs, and alphabet-soup agencies that prolonged the depressed conditions for 12 years. The program of intervention was started under a Republican administration and was kicked into full throttle by the Democratic administration that followed. In a chart of the real GDP of the United States from the beginning until recently, only two things stand out: the tendency of real GDP to grow over time and the Great Depression. There was nothing like the Great Depression before the 1930s, and has been nothing like it since, although we may now be on the cusp of a second such experience.
Nowadays, we have the TARP and the bailouts, followed by the stimulus; we have the expanded balance sheet of the Fed and quantitative easing, the nationalization of healthcare finance and the expansion of regulatory controls in the name of global warming. In part, these programs are motivated by the federal government's attempt to restart the economy, and in part to deliver on promises made during the election of 2008. But, they are also attempts to minimize the losses that will be suffered by the government because of its guarantees of mortgages, defined-benefit pension plans and bank deposits. And, instead of seeing a recovery, we see the country mired in a depression. These programs, too, were started under a Republican administration and accelerated by the Democratic administration that followed.
As for the second factor, taxes, during the 1930s, the top federal income-tax rate was raised from 25 to 80 percent, with other rates being raised in tandem. Even with such confiscatory tax rates, the federal budget remained in deficit. How could that have been? The obvious answer to anybody who isn't crackbrained or a progressive is that people don't work for the sheer joy of lowering the deficit.
Of course, progressives believe that people in the private sector are basically idiots and, so, probably don't even know what they're making after taxes. This is an article of faith in their religion and, believing in freedom of religion, I'm not going to disparage them for this belief. This is why I distinguish progressives from the crackbrained.
Nowadays, the tax rates haven't been raised. Instead, the government is spending at a rate of deficit that is unprecedented in peacetime and will soon eclipse even the deficits associated with WWII. But, if we suppose that people in the private sector have a modicum of intelligence (that is, if we're not progressives), the effect of such deficits would be as though we had raised taxes. This is because these deficits imply that taxes will be raised to confiscatory levels in the future or else the government will have to make what are, at least at this time, politically impossible cuts in spending.
Again, for progressives, the idea that people in the private sector would notice that their government is insolvent is not realistic. But, if people in the private sector are rational, then deficit spending at this time would be like pouring gasoline on a fire. It would only make the prospects for the future even worse. Instead of stimulating the economy, it would contribute to the uncertainty that is already paralyzing investment. Thus, without any arrows in the quiver of the Keynesian policy tool chest, there would be no hope for an economy. This is where Judge Posner sees us.
But I say to Judge Posner, look to Hayek on the business cycle, the way you did on law and economics.
Note: The views expressed on Mises.org are not necessarily those of the Mises Institute.