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What To Do About the Recession

October 31, 2001

With the latest news that the U.S. economy officially has been shrinking, it is time to admit the obvious: We are in a recession.  Consumer spending is down, along with business investment.  The only people making money these days are those who contract with the Pentagon.

Some are claiming that the attacks of September 11 triggered this latest economic slide, but all signs point to the fact that the U.S. economy already was in recession even before the attacks.  Moreover, there is no scarcity of counsel to be given to those we are told are "in charge" of the economy, as though there are a few people who can just pull the right levers to make things work.  For the most part, we hear the pundits telling everyone else what must be done to "stimulate" the economy in order to drive it from the doldrums.  Good luck.

Actually, I would like to give some advice of my own to the august chairman of the Federal Reserve System, Mr. Greenspan: Quit, and close down your whole operation.  You will not be missed.  

Of course, that is not what we are hearing from the pundits.  Instead, the word from nearly all quarters is for the Fed to continue to cut interest rates, which it has already done on numerous occasions, with the results being that the economy still falters.  We also hear calls for new tax cuts that should be targeted to people who would "spend money" and thus "stimulate" the economy.

As an Austrian economist, I am always for tax cuts and more tax cuts, because lower taxes mean a smaller state.  However, to say that the chief purpose of government policy is to "stimulate" the economy is to engage in silly talk.  For all its alleged great powers, the government cannot stop this recession.  The government and its wrongheaded policies are responsible for this economic calamity, not the hijackers who murdered several thousand people, as dreadful as that act was.  (No doubt, even if the economy were strong, U.S. productivity would be down in the wake of such a terrible event.)  The problem is simple: Bad ideas are leading to bad policies.

American economists like to think of themselves as a sophisticated lot, but to read their numerous policy prescriptions gives further proof that few in that profession have progressed beyond Bernard de Mandeville's The Fable of the Bees, or Private Vices Public Benefits.  The difference between the admonitions given by someone like Paul Krugman in the New York Times and Mandeville in Fable of the Bees is that Mandeville was a better writer.  For that matter, "I Want to be a Consumer," which appeared in the April 25,1934, edition of Punch, describes the Keynesian fallacies even better than Keynes and Krugman could do themselves.  At least the editors of Punch realized that "stimulating" consumption was a joke, while Krugman takes Keynesianism quite seriously.

Despite the fact that Keynesian "theory" has been discredited time and again, it always makes a comeback.  The only point of argument these days seems to be what kind of "stimulus" the economy requires, as opposed to why this business-cycle bust has happened in the first place.  Until people understand why we are in recession and what must be done for the economy to climb out and avoid this problem in the future, we are doomed to repeat these failures time and again.

First, repeat after me: Greenspan did not cause this recession by raising interest rates in 2000.  That is correct.  Instead, Greenspan helped caused this recession by lowering interest rates during the late 1990s.  To put it another way, Greenspan's "cure" to fight business-cycle downturns is actually responsible for the problem it was trying to correct.

Conventional wisdom goes as follows: the health of the economy directly depends upon aggregate demand.  If consumers are confident and secure, they will spend money and the economy will flourish.  However, if consumers lose confidence or if they believe the future to be uncertain, then they will withhold some spending and drive the economy into recession.  Thus, we have been hearing articles about the "heroic consumer" who was supposedly propping up the economy until losing heart after the September 11 attacks.  The terrorists who destroyed the World Trade Towers and damaged the Pentagon committed murder and mayhem; however, they are not guilty of causing a recession that was already inevitable.  Greenspan did just fine on his own, thank you.

Second, in order to "stimulate" the economy, we must rebate tax dollars to consumers so they will spend it quickly; so say the Keynesians.  At this point, people on the "right" and "left" disagree who should be the main beneficiaries of tax cuts.  So-called conservatives argue that cuts in capital gains taxes and of high marginal income tax rates will stimulate investment, while leftists hold that lower-income people should receive most of the cuts, since they are likely to spend money instead of saving or investing it like upper-income individuals might do.

While Austrians obviously would be more sympathetic to the former proposal than the latter, most people involved in the current public discussion of economics actually are clueless about what causes business cycles.  Furthermore, their ignorance of the reason economies run through boom-and-bust cycles blinds them to the real damage done by government policies, regardless of which political party holds power.

Although I agree that the government should slash tax rates, I believe so out of a matter of principle, not because I believe that government has the power to "stimulate" private investment.  That the economy is in recession in the first place is testament to the policy failures of the U.S. government.

In going back to an earlier statement, let me say again that the inevitability of this current recession began when the Fed began to force down interest rates during the mid-1990s.  The Fed's actions had a major role in triggering a boom, especially in the high-technology sector of the economy.  As the boom continued, it was fed by artificially low interest rates and a false belief that we had entered a "new economy" in which business cycles were a thing of the past.

Austrian economists--and only the Austrians--were pointing out that the boom was not a new era of prosperity that had been created by former President Bill Clinton's 1993 tax increases or Secretary of the Treasury Robert Rubin's brilliant business strategies.  While we need to acknowledge that some of the business, transportation, and financial "deregulation" (or re-regulation) of the late 1970s and early 1980s improved the basic climate for business investment, the Greenspan-led boom created an atmosphere in which billions of dollars became malinvested into lines of production that could not be sustained, especially in the high-technology and Internet sectors.  

Once those malinvestments took place on a huge scale, it became inevitable that a recession would occur.  To put it another way, there was no avoiding a bust, once those billions of dollars found their way into unsustainable lines of production.  

What about the present efforts of the Fed to stave off the recession by lowering interest rates?  For one, those malinvestments that once responded to lower interest rates have either been liquidated or are not looking to borrow large sums of money.  Thus, at best, this effort by the Fed to create massive new amounts of bank reserves is ineffective.

However, it is doubtful that we can easily walk away from this newest mess that Greenspan has created.  Would that the Fed were doing nothing more than creating new reserves that won't be used at all.  Unfortunately, that is not the case.  By performing aggressive open market operations and by forcing interest rates below the rate of inflation, all of which are increasing the U.S. money supply at very high rates, the Fed is basically setting the stage for the next wave of malinvestments--even before investors have had the opportunity to malinvest their funds!

What should be the proper response, given all that the Fed and the U.S. government have done to cause this calamity?  Murray N. Rothbard, in his classic America's Great Depression, eloquently answers that question:

If government wishes to see a depression ended as quickly as possible, and the economy returned to normal prosperity, what course should it adopt?  The first and clearest injunction is: don't interfere with the market's adjustment process.  The more the government intervenes to delay the market's adjustment, the longer and more grueling the depression will be, and the more difficult will be the road to complete recovery. (p. 25, italics in original.)

The prescription for recovery could hardly be clearer.  Yes, cut taxes to the bone, because the lower the burden of government, the more private investment there will be, and it will be investment that can be sustained, not the malinvestments triggered by Greenspan and his allies at the Fed.  Furthermore, the regulatory state we have created should be cut back severely or, even better, abolished altogether.

This recession does not have to last for a long time.  We have the tools in hand to drastically shorten this economic downturn.  It is just that most people don't know where to look or, instead, are mistakenly trying to use tools that caused the trouble in the first place.


William Anderson, an adjunct scholar of the Mises Institute, teaches economics at Frostburg State University.  Send him MAIL.  See his Articles Archive. The Mises Institute is holding a Private Retreat with Austrian Economists, January 18-19, 2002.


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