Well, the macroeconomists are at it again: Which is more important for economy-wide stability and fighting recessions, monetary or fiscal policy? Harvard University economist, Kenneth Rogoff, insists that fiscal policy is too short-run politicized for “managing” the economy. Better to leave it in the “independent” hands of central bank technocrats who know what they are doing. British economic historian, Robert Skidelsky, replies that monetary policy gave us the financial crisis of 2008-2009, so it’s time to give independent authority to technocratic fiscal policy elites to micromanage the macroeconomy to assure full employment.
Not part of the debate, unfortunately, is the idea that it has been “activist” monetary and fiscal policies by self-proclaimed “technocratic” social engineers that have helped cause and exacerbate the booms and busts of the business cycle.
So, in my article I explain why Federal Reserve monetary policy basically has been a destabilizing mess in America for more than a century. It is time to “think outside the box,” and take seriously the benefits from denationalizing money and moving to a private, competitive free banking system.
Likewise, the coronavirus-like Keynesian fiscal policies have caused a “pandemic” of government deficits and national debt. It’s time to cut government down to classical liberal size and end the taxing and spending disease caused by the interventionist-welfare state.
The Technocrats Will Not Save Us
by Richard Ebeling
Besides the certainty, as they say, of death and taxes, one other highly likely event will be an end to the general “good times” of relatively low price inflation and low unemployment in America. In other words, the United States will eventually experience worsening inflation at some point, as well as another general economic downturn. The question is, what should government policy be, if anything?
Macroeconomists are dueling, once again, over whether the primary policy tool for preventing or mitigating the next recession should be monetary or fiscal policy. The idea that it might be “activist” monetary and fiscal policies that cause and exacerbate the booms and busts of the business cycle never seems to be an element of the debate. Maybe it should be.
The Call for Fiscal Technocrat Stabilizers
British economic historian, Robert Skidelsky, has recently made the case that after several decades of excessive reliance on monetary policy to keep the economy on an even keel, it is time to place fiscal policy once more at the helm of macroeconomic stabilization problems.
Monetary policy had its chance, Skidelsky says, in failing to anticipate, prevent, or successfully mitigate the financial and economic crises of 2008-2009. Clearly, economy-wide stability cannot be left to the central bankers alone, especially since they do not have the policy tools to directly influence prices in general or the general levels of employment and output.
Government taxing and spending policies must be relied upon in the future to more directly stabilize the economy. Central to his argument is the plea for economists to be more “open to the idea of a public-sector job guarantee of the sort envisaged by the 1978 Humphrey-Hawkins Act in the US, which authorized the federal government to create ‘reservoirs of public employment’ to balance fluctuations in private spending.”
In other words, Skidelsky calls for a return to a modified version of the original Keynesian notion that during recessions governments should run budget deficits to “stimulate” employment and output and run surpluses during periods of full employment when government-generated jobs are not as needed.
Skidelsky admits that fiscal policies can be misused in the short-run battles over government spending in the service of political party advantage. But rather than simply dismissing taxing and spending policies because of some possible negative effects and political abuses that may occur, he says that macro-policy analysts should focus on reinforcing these counter-cyclical policies in the form of better institutionalized “automatic stabilizers” less open to such abuse.
He does admit that “both the design and implementation of such a job guarantee would give rise to problems,” but he is confident that, “We have the intelligence to do better.” Given a free hand, the fiscal technocrats can be trusted to effectively manage the taxing and spending ship of state to assure calmer waters.
The Call for Central Banking Technocrats
Robert Skidelsky’s column for the “Project Syndicate” website was in response to an earlier column published on the same website by Harvard University economist, Kenneth Rogoff, who defended the primacy of monetary policy in the management of the macroeconomy.
Rogoff warns, “The past decade has seen a rise in fiscal evangelism among many economists and policymakers.” They create the impression that a handful of “technocratic” economic policy experts may be trusted to rationally and reasonably design the right fiscal policy calibrations to get just right the balancing act of maintaining full employment while warding off any danger from price inflation.
The reality, Rogoff says, “is that in most countries today, economic policy is highly polarized, with decisions being made by razor-thin majorities. In the United States, for example, fiscal policy for Democrats largely means an opportunity to engage in more spending and transfers. For Republicans, it means cutting taxes in order to downsize government. Such differences are a recipe for seesaw policy.”
He adds that, “As a short-run stabilization tool, fiscal policy will inevitably be difficult to time and calibrate in the same way that central banks have succeeded in doing with monetary policy.” Indeed, Rogoff believes that, “The modern, independent, technocratic central bank is arguably the greatest innovation in macroeconomics since John Maynard Keynes pioneered demand management.”
In Rogoff’s view, “The right solution is not to cast aside monetary policy, but to find ways to strengthen its effectiveness in a low-interest rate environment, possibly by finding ways to use negative rates more fairly and effectively.”
The Common Theme: Monetary and Fiscal Planning
In spite of their apparent difference in approaches to macroeconomic policy, that is, with primary reliance, respectively, on either fiscal or monetary policy in an attempt to prevent and mitigate economy-wide fluctuations in employment, output, and prices, both Robert Skidelsky and Kenneth Rogoff share a central policy premise.
That premise is that market economies require activist fiscal and monetary policies, and that it is possible to devise one or the other of these policy toolkits (or some combination of monetary and fiscal policy) that can successfully micro-manage the macroeconomy.
All that is needed is the “correct” team of economic policy “technocrats” with sufficient autonomy from the policy pressures of everyday politics to get the job done. In other words, both Skidelsky and Rogoff are competing proponents of fiscal and monetary central planning. They differ only on the policy tools on which to place the greater emphasis, and the particular targets and techniques to bring about the desired common goal of economy-wide stability that cannot be assured, both say, without the intervening hand of government “experts” in the art of social engineering.
What is also of note is that both are right in their criticisms of the other, and when combined demonstrate why the best macroeconomic policy is to have neither fiscal nor monetary policy “activism.” The fact is, monetary policy has failed over and over again during the last one hundred years in the United States, during which we have had an “independent” central bank.
The Failure of Monetary Central Planning
The Federal Reserve, shortly after opening its doors in 1914, generated significant price inflation during America’s participation in the First World War, in financing a good portion of the federal government’s war-related expenditures. In the 1920s, it followed a policy of attempted price level stabilization through monetary expansion that funded the unsustainable stock market and related boom that set the stage for the crash of 1929. Monetary policy then exacerbated the magnitude and intensity of the economic downturn, thereby helping to create the Great Depression of the 1930s.
The post-World War II period was punctuated by a series of booms and recessions in the 1950s fostered by central bank policy, including the Fed’s funding of the government’s deficit spending needs during the Korean War. The Federal Reserve, again, facilitated the needed money for the pursuit of both “guns and butter” during the Vietnam War and the Great Society programs. (See my article, “Paternalistic Follies of the 1960s.”)
This set the stage in the 1970s for the worst price inflation since the Civil War a century earlier. Relatively loose monetary policy also accommodated the “high tech” boom of the 1990s that brought about a recession at the start of the 21st century.
Then, in 2003, the monetary central planners at the Federal Reserve became fearful of a possible price deflation, so they opened the monetary spigots, increased the money supply in the neighborhood of 50 percent over the next five years, and pushed nominal interest rates nearly to zero, with inflation-adjusted real interest rates in the negative range. This, combined with the government-induced housing boom through Fannie Mae and Freddie Mac mortgage guarantees, generated the conditions for the financial and economic crisis of 2008-2009. (See my article, “Ten Years On: Recession, Recovery and the Regulatory State.”)
And, again, for the last ten years, the Federal Reserve has manipulated and kept interest rates nominally near zero, with real, inflation-adjusted interest rates in that negative range. The central bank added around $4 trillion to its portfolio by purchasing government and mortgage-backed securities. The only reason that this has not led to the noticeable price inflation that some of us expected is that the Fed introduced a new “trick” to its grab-bag of policy tools; it has paid banks interest not to lend a large portion of the huge sums of money that its own monetary policy injected into the banking system.
Interest Rates and the Banking System Need to be Free
What is lost in most of the discussions over central bank monetary policy is that in a functioning market economy the banking system is supposed to play the role of the intermediary institution bringing about a coordinated balance between the real savings of income earners and those interested in borrowing that savings for various credit-worthy investment and related purposes.
Interest rates are among the intertemporal prices that are to not only bring about a balance between savers and investors in general but a coordination between the savings plans of income earners with the time horizons of borrowers’ periods of investment. (See my article, “Interest Rates Need to Tell the Truth.”)
Financial markets subject to monetary and interest rate manipulation by central banks are short-circuited in their ability to serve this vital function in the social system of division of labor. In other words, “activist” monetary policy meant to assure or maintain macroeconomic stability only serves to bring about the very economy-wide fluctuations that monetary intervention is supposed to prevent. (See my article, “The Myth that Central Banks Assure Monetary Stability.”)
It is why there needs to be and there is an alternative to government monetary policy: It is for the denationalization of money and the monetary system through a move to private, competitive free banking. The market – which means everyone participating in the production and consumption, the supplying and demanding, of goods and services – should determine what medium (or media) of exchange is more advantageous to use for various transaction purposes.
And private banks, through the checks and balances of market-based and incentivized competition, should coordinate the savings of some with the investment plans of others, as well as the supply of money in the banking system with the demand to use and hold cash balances by those who buy and sell through the medium of money. (See my article, “Central Banking is Central Planning” and my eBook, “Monetary Central Planning and the State.”)
Politicians Cannot Be Trusted with the Power to Borrow
Equally misdirected is Robert Skidelsky’s case for activist fiscal policy. The dangers from unrestrained government spending and borrowing were understood already at the beginning of economics as a field of study. In 1741, for instance, the famous Scottish philosopher, historian and political economist, David Hume (1711-1776), warned in his essay, “Of Public Credit,” that those in political power could not be trusted to resist the temptations of spending to further their own purposes, and especially with borrowed money. Said Hume:
“It is very tempting to a minister [in the government] to employ such an expediency, as enables him to make a great figure during his administration, without overburdening the people with taxes, or exciting any immediate clamors against himself. The practice, therefore, of contracting debt will almost infallibly be abused, in every government. It would scarcely be more imprudent to give a prodigal son a credit in every banker’s shop in London, than to empower a statesman to draw bills, in this manner, upon posterity.”
The same warning was offered more than a century later by the American economist, Dudley Baxter (1827-1875), in his still insightful book on National Debts (1871). Borrowing enables those in public office to create the illusion that the citizens can partly get something for nothing, since the burdens of interest payments on a growing national debt due to deficit spending is a fraction of what the voters would discover to be the real cost of all that government spends if it were to be fully covered by taxation. Baxter explained:
“When money is raised by taxation within the year for which it is needed, the amount that can be raised is limited by the tax-enduring habits of the people and must be as small as possible in order not to provide discontent. By the same reason it must be spent economically and made to go as far as possible.
“But when the money is raised by loans, it is limited only by the necessity of the interest [payment] not to be too large for the taxable endurance of the people or provoking their discontent. Hence the limits of borrowing are about twenty times larger than the limits to taxation, and an amount that is monstrous as a tax, is (apparently) a very light burden as a loan. In consequence, borrowing is freed from the most powerful check that restrains taxation. . .
“When a loan is obtained the reason for economical expenditure is equally wanting, and borrowed money is commonly expended with much greater profuseness, and even wastefulness, than would be the case with taxes.”
Balanced Budgets vs. Democracy in Deficit
Finally, Nobel Laureate James M. Buchanan (1919-2013) and Richard E. Wagner persuasively detailed in Democracy in Deficit (1977) that before the Keynesian Revolution of the 1930s, it was generally understood that the most honest and transparent policy for a government to follow was that of a targeted annual balanced budget.
First, while there always are distributional effects from the incidence of upon which members of a society the burden of actual taxes may fall, it is nonetheless the case that the citizens can have a relatively clearer understanding of what the costs are of all that the government does when the expenditures for the year are covered by taxes collected in the same time frame.
And, second, a balanced budget rule means that those in or running for public office cannot create that false impression of being able to give voters something for nothing when they are obligated to explain how much the promised programs will cost and upon whom the fiscal burdens will fall; or if taxes are not to be raised, to explain which existing government programs are to be reduced or eliminated to transfer the needed funds for the new or increased expenditures in a different direction.
But with the coming of the Keynesian argument that government should run balanced budgets over the phases of the business cycle instead of on a yearly basis, the floodgates were opened for politicians to do what is in their life blood: spending other people’s money to serve their political purposes. For those politicians to be able to rationalize government spending through borrowing without having to immediately burden prospective voters with the full tax expense of what they do, it becomes an irresistible temptation that few of those in political life are able to resist.
Unrestrained in terms of the size and scope of government activities on which money may be spent, and without any restrictions on the ability to borrow and accumulate national debt, modern democracy has become a political system addicted to continuing and seemingly increasing annual deficit spending.
Those in government, regardless of the political party or the platforms on which their candidates for elected office may run, cannot be trusted with unlimited access to the public purse. That is why Robert Skidelsky’s naïve presumption that wise fiscal technocrats freed from everyday politics should be given the power to tax and spend as they think best for an illusionary macroeconomic stability will only lead to more fiscal disaster. (See my article, “Why Government Deficits and Debt Do Matter.”)
The Need for Reducing the Size and Scope of Government
What is required is more than a balanced budget amendment to the Constitution, however desirable as a constraint on government spending that may be. Only reining in the size and scope of the responsibilities and duties of government can offer the longer-run institutional limit on the expenditure and regulatory reach of those in political office.
This, however, requires a change in the political and ideological currents within the country, without which government will continue to grow through taxed and borrowed funds. An essential complement to this is a rejection of the notion that all that a country needs for macroeconomic stability are monetary and fiscal technocrats with unlimited “independent” power to do as they want based on the hubris of policy elites who assert their knowledge, wisdom and ability to manage our lives better than we ourselves.
We need constitutionally limited governments restrained to securing the life, liberty, and honestly acquired property of the citizens of each country, and not devoted to regulating, redistributing and planning the lives and livelihoods of the individuals comprising the societies of the world.
In other words, freeing ourselves from the hubris of the monetary and fiscal technocrats and the political power-lusters preying after people’s peacefully and productively earned incomes and wealth requires a reborn understanding of, and confidence and belief in the value and importance of personal and social freedom combined with principles and practice of free market liberalism. (See my book, For a New Liberalism.)
Dr. Richard Ebeling is the BB&T Distinguished Professor of Ethics and Free Enterprise Leadership at The Citadel, in Charleston, South Carolina.
Dr. Ebeling is the author of Austrian Economics and Public Policy: Restoring Freedom and Prosperity (2016); Monetary Central Planning and the State (2015) as well as the author of Political Economy, Public Policy, and Monetary Economics: Ludwig von Mises and the Austrian Tradition (2010) and Austrian Economics and the Political Economy of Freedom (2003). And the editor of the three-volume, Selected Writing of Ludwig von Mises, published by Liberty Fund.
He is also the co-editor of When We Are Free (Northwood University Press, 2014), an anthology of essays devoted to the moral, political and economic principles of the free society, and co-author of the seven-volume, In Defense of Capitalism (Northwood University Press, 2010-2016).