Figure 6.1 Laffer Curve
Source: Wikimedia commons, free license
Just as Democrats, Republicans, and others have different views on politics and public life, there are also different “parties” and schools of thought on economics and the economy. These schools of thought, like the political parties, have their leaders and their followers, and many of them, like “supply-side economics,” work their way indelibly into the political vernacular.
Beyond such popular political panaceas, anybody who has spent time reading the papers or trying to understand this nebulous thing we call the economy has doubtless run into terms like “fiscal policy” and “Keynesian economics” and “monetary policy” and the “Chicago school.” It’s sophisticated stuff, most originating from the academic world, and hardly food for pleasant family dinner conversation, at least in most families.
But these schools of economic thought are interesting and important for anyone wishing to know how an economy works, and what “knobs and dials” can be used to control it. And the debate around which school works best or explains some kind of crisis can be interesting stuff—if you take it in small doses, like the summaries following. Otherwise, economic schools and their discussion can go into reams of articles and books and be about as dry as a southern Arizona zephyr.
Have no fear. As with other principles described in this book, the economic schools are presented on a “what you need to know” basis.
In the natural course of business and commerce, the economy may expand, contract, or linger in the doldrums, creating pleasure or pain for individuals, corporations, and society as a whole (see #8 Business Cycle). As a measured effort to provide some stability and reduce pain among certain individuals or sectors of the economy, governments try to influence the economy, and smooth out the down cycles in particular.
There are two primary ways the federal or any national government can influence the economy: fiscal policy and monetary policy. Fiscal policy is the use of government spending and tax policy (see #47 Tax Policy and Income Taxation) to put money into or take money out of the economy. Monetary policy (see #56), on the other hand, influences the economy through changes in the money supply and interest rates (see #17 Money Supply and #21 Interest Rates).
By congressional design or approval, governments can change the level and direction of spending quickly. As a first step in the recovery plan for what turned out to be the Great Recession, Congress passed the American Recovery and Reinvestment Act of 2009, providing more than $700 billion in new, “shovel-ready” spending programs across the country. This is the largest and one of the most quickly passed fiscal stimulus packages in history.
Fiscal stimulus programs like this are designed to provide jobs and thus stimulate aggregate economic demand by giving earners the ability to spend more money. Some stimulus packages are also designed to help certain parts of the economy (as opposed to the whole), or to strengthen or encourage specific sectors. The 2009 stimulus package, for instance, contained spending for alternative energy technologies. Some fiscal stimulus programs can help reduce the effects of poverty or accomplish other social or distribution-of-income objectives.
Stimulus may also be accomplished by reducing taxes, as was done several times since the beginning of the Reagan administration in the early 1980s. The tax rebate checks sent to most Americans during 2008 and the 2 percent “holiday” on payroll taxes in effect for 2011 and 2012 were more recent examples.
Fiscal policy can also be used dampen or attenuate an economy. This can occur either by reducing spending (difficult to do politically in the short run) or by raising taxes.
Economists are somewhat split on the effectiveness of fiscal policies. As recently demonstrated, tax reductions and especially tax rebates during tough times can simply be used for saving and thus don’t stimulate the economy (see #35 Paradox of Thrift). Government spending increases and decreases can be very political. They may not be allocated to the greatest need but rather subject to intense lobbying, resulting in waste and a significant loss of time before the benefits are realized (even the rapidly passed 2009 law wasn’t expected to have real effect for as much as a year). For these reasons, many believe that monetary policy is more effective, but it has boundaries too. Notably, Congress controls fiscal policy while the Federal Reserve (see #30 Federal Reserve) controls monetary policy. Most likely, a combination of the two works best, as has been deployed over the course of time (see #57 Keynesian School and #58 Chicago School).
Government is in place to use your tax dollars to make your country a better place to live; fiscal policy is one of the biggest tools it has to do this. How the government spends money is important, as are the size and nature of the budget deficits that may result (see #42 Federal Deficits and Debt). Fiscal policies, especially those involving tax changes, are likely to affect you.
While fiscal policy moderates economic growth and stability directly through government spending and taxation, monetary policy does it a bit more indirectly by controlling the supply of money and its cost through interest rates.
When there is more money in the system, in theory and usually in practice, there is more economic activity. People have more money to make purchases or to pay off debts to enable more purchases later. The Fed can put more money into the system directly or by reducing interest rates through open market operations (see #32 Fed Open Market Operations).
Adding money to the system usually has a fairly rapid effect, for it stimulates lending and also sets expectations of easier money down the road; business decision-makers have more dollars to chase both now and in the future. But putting more money in the economy to chase the same amount of goods and services, especially when the supply of certain key goods is constrained, as happened in the 2008 oil market, can be highly inflationary—those additional dollars make all dollars worth less.
Monetary policy also influences exchange rates (see #92 Currency Policy and Exchange Rates), which in turn can stimulate or attenuate an economy. Lower interest rates make the dollar relatively less attractive because foreign investors will receive less interest on their holdings. This drives down the value of the dollar against world currencies, which also stimulates U.S. demand as prices for American goods become relatively more attractive to overseas buyers.
Over time, monetary policy has received greater emphasis as a tool to regulate the economy. One big reason is that it works quickly and largely without congressional approval. Policymakers feel they’ve learned how to moderate the business cycle quickly and efficiently with it, and have learned how to adjust all the knobs and dials (not just interest rates) to achieve desired outcomes. The quantitative easing bond-buying programs of the past few years are an excellent example.
Critics feel the overuse of monetary stimulus has left the door open for serious inflation problems in the future as money supply increases have hit all-time records. Many now advocate slow and steady monetary growth—not harsh expansion and contraction cycles tied to big increases and decreases in the Fed funds rate—as the proper way to achieve economic prosperity and stability.
Monetary policy will affect your daily life. Most of the effect is indirect, via a healthy and more stable economy. If you’re in the market for a mortgage or a short-term loan, monetary policy will have some effect on the interest rates you’ll pay. Since monetary policy takes aim mostly at short-term interest rates, however, the effect on longer-term mortgage rates is not direct. Monetary policy will also affect the amount of interest you receive on savings. Finally, we all should be aware of the potential long-term effects of monetary growth on inflation (see #18 Inflation and #59 Austrian School).
The Keynesian school, often referred to by other names like Keynesian economics or even the somewhat haughty “neoclassical synthesis,” is a school of analysis and thought about the greater economic environment and the role that government should play in that environment. Essentially, the Keynesian school believes strongly in the theory and practice of capitalism but holds that government intervention, in several forms, is necessary to smooth the bumps and keep capitalist societies on a healthy, steady, and prosperous course.
Keynesian economic theories went public during the Great Depression, and were the basis for British economist John Maynard Keynes’s 1936 book The General Theory of Employment, Interest and Money. At that time, economists and policymakers were intent on finding causes and cures for the depression under way, which many attributed to a complete failure of the capitalist model. Keynes set out to prove that capitalism was okay, it just needed some government intervention occasionally, and that intervention should never be mistaken for government control—that is, a planned economy.
The Keynes view holds that without intervention, the economy will function, but not optimally. Businesses and business leaders can make suboptimal decisions based on incorrect perceptions or lack of information. This leads to underperformance, or in some cases “overperformance,” a boom led by unrealistic expectations. These decisions and overreactions lead to suboptimal demand, loss of output, and unemployment, which of course then serve to make the situation worse. In this view, government policies, including fiscal and monetary stimulus, would be used to increase aggregate demand and economic activity. That stimulus would travel through the economy several times, creating a multiplier effect directly proportional to the velocity with which it traveled.
Monetary stimulus, to resolve the Great Depression at that time, would be accomplished through massive government investments and by lowered interest rates. Both were done, most particularly the government investments through WPA and other programs. Ironically, the theory was really proven effective by the economic boost given by World War II. Keynes also went against the grain in maintaining that deficits were okay, governments didn’t need to balance budgets in the short run, and increased economic activity would fill budgetary gaps later. It should be noted that Keynes did not advocate deficit spending per se, but rather as a necessary investment to smooth economic cycles.
The details of the theory and the effects on wages, prices, and so forth are much more involved and complicated. Over time, U.S. government policy has embraced Keynesian economics, although elements of the Chicago school (or Monetarist school) are also deployed. The Austrian school, favoring little to no government intervention as a way to remove inefficiency more quickly, takes an opposing and intellectually enticing point of view. These are covered in the next two entries.
In your normal life you won’t be confronted with having to decide whether you’re a Keynesian, or with the task of implementing Keynesian policy. But it’s helpful to understand the underpinnings of government policy, and why the government does what it does. Those actions do affect you.
While John Maynard Keynes favored government intervention to smooth supply and demand for goods and services as a way to achieve economic growth and stability (see #57 Keynesian School), another school of thought claimed that stability was a matter of equilibrium between supply and demand of money, not the goods and services themselves. This school of thought, largely held by members of the University of Chicago faculty, most notably Dr. Milton Friedman, is known as the Chicago or Monetarist school.
Monetarism focuses on the macroeconomic effects of the supply of money, controlled by the central banks. Price stability is the goal, and policies like Keynesianism, which can lead to excessive monetary growth in the interest of stimulating the economy, are inherently inflationary.
Monetarists hold that authorities should focus exclusively on the money supply. Proper money supply policy leads to economic stability in the long run, at the possible expense of some short-term pain. Monetarists are more laissez-faire in their approach—that is, the economy is best left to its own actions and reactions. To the monetarist, money supply is more important than aggregate demand; the pure monetarist would increase money supply (in small, careful increments) to stimulate the economy rather than take more direct measures to stimulate aggregate demand. The Great Depression, in the Chicago school, was caused by a rapid contraction in money supply, brought on in part by the stock market crash, not a contraction in demand per se.
To the monetarists, the more direct approaches to stimulating aggregate demand are considered irrevocable (once the government intervenes, it is difficult to disengage). Worse, they crowd out private enterprise as government thirst for borrowed money to fund stimulus makes it harder and more expensive for the private sector to borrow. Monetarists also suggest that Keynesian stimulation changes only the timing and source but not the total amount of aggregate demand.
The monetarist point of view has always been embraced by policymakers who endorse a tight vigil over money supply in addition to more traditional fiscal stimulus and interest rate intervention. Fed Chairman Paul Volcker, and later Alan Greenspan, were monetarists, although critics are quick to point out that Greenspan got carried away and created too much growth in money supply, which led to strong boom and bust cycles in stocks and later in real estate. It did not lead to the expected inflation, thanks in part to the availability of inexpensive goods from Asia. We got lucky, but this attenuation of inflation may be unsustainable, particularly with the recent growth in money supply used to mitigate the Great Recession.
Unless you aspire toward a degree in economics, you don’t need to be too familiar with the details of the Chicago school, nor its many proponents from the Windy City. The greater interest is in knowing where policy comes from and why.
The Austrian school, while founded in Vienna long ago, has largely emigrated to the United States. One of its strongest proponents, Friedrich Hayek, a University of Chicago faculty member, popularized many of its teachings in the mid-twentieth century.
The basic premise of the Austrian school is that human choices are subjective and too complex to model, and thus it makes no sense for a central authority to force economic outcomes. Like monetarism, but to a greater degree, it is a “laissez-faire” economic philosophy.
The Austrian school takes the contrarian view that most business cycles are the inevitable consequence of damaging and ineffective central bank policies. Government policies tend to keep interest rates too low for too long, creating too much credit and resulting in speculative economic bubbles and reduced savings. They upset a natural balance of consumption, saving, and investment, which, if left alone, would make the consequences of business cycles far less damaging.
The money supply expansion during a boom artificially stimulates borrowing, which seeks out diminishing or more far-fetched investment opportunities (like Florida real estate in 1925–1928 and again in 2005–2007), and more recently an outsized interest in high-yield bonds and other riskier fixed-income securities. This boom results in widespread “malinvestments,” or mistakes, where capital is misallocated into areas that would not attract investment had the money supply remained stable.
When the credit creation cannot be sustained, the bubble bursts, asset prices fall, and we enter a recession or bust. If the economy is left to its natural path, the money supply then sharply contracts through the process of deleveraging (see #9 Deleveraging), where people change their minds and want to pay off debt and be in cash again. If governments and policy get involved to mitigate the pain of the bust by creating artificial stimulus, they delay the inevitable economic adjustments, making the pain last longer and setting us up for more difficulties later—harsher cycles and more inflation. Furthermore, so-called “creative destruction”—the weeding out of inefficient or uneconomical businesses and investments in favor of efficient ones—is delayed or avoided entirely, much to our long-term detriment.
The recent boom and subsequent Great Recession had many of the footprints of the Austrian scenario. A credit-stimulated overexpansion led to a bust; the government didn’t know what to do about it; bad businesses and business models, like many banks, were propped up. In the Austrian school such businesses should be allowed to fail, for the economy will return to health more quickly, and a patient once on medicine will always require medicine.
Hayek himself criticized Keynesian policies as collectivist and never temporary. Perhaps Austrian school economist Joseph Schumpeter, who coined the term “creative destruction,” summed up its point of view best in 1934: “Recovery is sound only if it does come of itself.”
The Austrian school may seem radical, perhaps radically conservative, and almost antigovernment in nature. That said, many of the symptoms proponents talk about, and much of their analysis of the Great Depression, resonates. It should help you maintain a healthy skepticism of government action, though most economists don’t go this far in condemning the role of government. As an individual, it helps to have a balanced view of what’s going on, and to understand the upsides and downsides of any government intervention. By the way, Austrian school disciple Murray Rothbard’s America’s Great Depression, Sixth Edition (CreateSpace Independent Publishing Platform, 2011) is a fascinating read if you enjoy this sort of thing.
Capitalism is founded on the notion that people produce goods and services under their own free will, and that they earn the appropriate rewards for their achievement. Supply-side economics extends this fundamental school of thought by arguing that the best way to achieve economic growth is by maximizing the incentive to produce, or supply goods and services. That’s best done by reducing taxes and regulation, allowing the greatest rewards, and allowing those goods to flow to market at the lowest possible prices.
The term “supply-side economics” is relatively recent, coming into the language in the mid 1970s. Supply-side economics spawned close cousins in the form of “trickle-down economics” (see #61) and Reaganomics (see #62); all three members of this happy family got a good test in the 1980s in the administration of Ronald Reagan.
Supply-side economics attempts to optimize tax rates—that is, marginal tax rates, or rates paid on the highest dollar earned. The optimization is achieved by setting the tax rate low enough to avoid discouraging individual production and earning, but high enough to encourage enough production and earning to maximize total tax revenues. That in turn offsets the potential loss in tax revenue by lowering the tax rates. Stated differently, the tax rate matters more to individuals, total taxes collected matters more to government.
The relationship between tax rates and total tax revenue is illustrated in Figure 6.1. The Laffer Curve is named for economist Arthur Laffer, the supply-side proponent who created it.
Figure 6.1 Laffer Curve
Source: Wikimedia commons, free license
The contrast between supply-side economics and other schools is illustrated by comparison with the Keynesian school, which contends that tax cuts should be used to create demand, not supply. The Keynesian school, by implication, would target the tax cuts toward lower-income earners who are most likely to spend, while the supply-sider would target them toward the higher-income earners, and especially business owners and leaders paying the highest tax rates. Doing so would stimulate the greatest increases in production; if these individuals faced 50 or even 70 percent tax rates, they would be less inclined to produce more and earn more (see #47 Tax Policy). The other end of the supply-side equation holds that the resulting economic growth from stimulated supply would make up for the loss in tax revenue.
The jury is still out on the effects of the supply-side “test” in the 1980s. Significant decreases in marginal tax rates were enacted and production did expand through the 1980s; the economy emerged from the Reagan administration far healthier than when he took office, even with the 1987 stock market crash. However, sufficient revenue was never generated to cover the tax decreases; the deficit grew persistently. That may have been caused more by increases in defense spending and other government programs than a failure in supply-side economics. Additionally, increased income inequality (the rich get richer, etc.) has also been a nagging criticism of supply-side policies.
More recently, supply-side economics has definitely been in the minds of the so-called “Tea Party” and other tax conservatives who believe even a slight increase (from 36 percent to 39.6 percent rates for top earners) tips the balance, but in effect through raises in Medicare taxes, capital gains taxes, and income taxes in many states, tax rates for the wealthy are going up anyway. Revenues have gone up considerably since the Great Recession, but still not enough to offset economic stimulus, spending increases, and growing entitlements (Social Security and Medicare). As such, the supply-side school has yet to fully prove itself, but there is a general feeling that things would be much worse if it had never come into play.
As an individual, particularly as an economically productive individual, you should favor the supply-side approach. It carries greater economic rewards for achievement, and makes hard work and investment more attractive. But before “buying” this approach from the politicians, make sure that the other end of the equation—government expenditures—are held in check. Otherwise, the additional tax revenues generated will not be sufficient and deficits will endure, putting America in a fundamental “box” of not being able to raise taxes if necessary. This mistake of the Reagan administration, and later the George H.W. Bush administration policy of “no new taxes,” took a lot of wind out of the sails of this promising approach. We saw it again in the second Bush administration, and though attenuated somewhat under Obama, the general concept remains in play.
The “trickle-down” school of economics carries a set of principles and actions very similar to supply-side economics (see #60), but the goal is different. While the supply-side school advocates stimulating production to benefit the economy as a whole and pay for the tax rate decreases that stimulated the production, the trickle-down school goes on to argue that increased production and wealth accumulated at the top will eventually “trickle down” to the masses.
The premise is based on the idea that more prosperous business owners and leaders will produce more and take more risks, providing jobs and higher incomes for the masses. Additionally, the supply-side premise that greater production at a lower cost will lead to lower prices for consumers also suggests better standing for the lower economic tiers of society. Trickle-down economics takes the supply-side approach and extends it to a premise and promise of greater societal benefit for everyone.
The problem, of course, is that the wealth created at the top doesn’t always trickle down so effectively. Many believe that quite the opposite happens—that the rich get richer, and not very much happens to anyone else. As William Jennings Bryan put it in the 1890s: “If you legislate to make the masses prosperous, their prosperity will find its way up through every class which rests upon them.”
Indeed, the trickle-down theory was never directly advocated by the Reagan and Bush leadership, but was a constant theme in the congressional debates on tax policy, which went something like this: The wealthy will get what they want, the budget will be balanced on the back of higher tax revenues, and it will help the lower classes too. Unfortunately, the second two parts of the scenario never really played out—government spending exceeded the new revenues, and the wealthy chose to keep a lot of their wealth. By almost any measure, the wealthy got wealthier through the period. Why that happened is a matter of conjecture. First, lower tax rates and especially capital gains tax rates encouraged them to save it for themselves, not create new production and thus jobs; or second, in the face of an economy where considerable production was moving overseas, there wasn’t enough job-creating activity to invest in.
Trickle-down economics, while attractive in principle, has still not met with measurable success in over 100 years of trying. When politicians declare that making the rich richer will help everyone, take that with a grain of salt. That said, the supply-side foundation that the “trickle-down” outcome is based on shouldn’t be dismissed as a bad idea.
Reaganomics, the phrase coined for the economic policies of the Ronald Reagan 1981–88 presidency, was essentially an implementation of supply-side economics tailored for the times (see #60 Supply-Side Economics). The major premise and promise was an across-the-board reduction in income and capital gains tax rates to bolster an economy recovering from the stagflation hangover of the late 1970s (see #20 Stagflation).
Ronald Reagan came into power in a particularly tricky economic period—one tricky enough that the traditional doses of monetary medicine would have made problems worse. The bulge in inflation in the late 1970s (see #18 Inflation) was caused by forces beyond monetary policy—that is, the supply shock and price escalation in the energy sector. Worse, inflation had become part of the daily mentality of consumers and business leaders alike; everyone expected it, and so raised prices defensively in advance of it. Inflation was a self-fulfilling prophecy.
The standard money-supply remedies for inflation were clearly not working. The Fed funds rate reached an all-time high in 1980 and led to the recession of 1981–82, but did not do as much to temper inflation or inflationary expectations as one would have hoped (see #21 Interest Rates). The challenge of the Reagan administration was to combat inflation and stimulate growth without relying on traditional monetary policy.
The solution was a hybrid of monetary and supply-side economics. The Fed began lowering interest rates to increase money supply; at the same time, supply-side initiatives of lower taxes and promises of better times spurred production. The increased production then consumed, or “mopped up,” the excess liquidity, or money, pumped into the economy. While more money chasing the same amount of goods and services leads to inflation, more money chasing more goods and services does not.
The Reagan administration, playing its “trickle-down economics” card to justify and pass the programs, used the expression “a rising tide lifts all boats” (see #61 Trickle-Down Economics). The economy rebounded while commodity prices fell at the same time—a rare combination that might be attributed to the combined policy. Detractors maintain that the high interest rates alone (they were declining, but still historically high—see Figure 3.1) brought the fall in commodity prices, but this argument seems out of place, because the economy was indeed rebounding.
Tax revenues—at least nominal, or not inflation-adjusted—grew. They fell as a percent of GDP, but that was intended and expected with lower tax rates. Real tax revenues did not increase, however, until 1987. It should also be noted that while federal income tax rates dropped, FICA taxes for Social Security and Medicare, as well as taxes in many states, increased.
Still, it looks like Reaganomics was indeed a dose of innovative medicine that worked for the most part. If it had been pulled off with a balanced budget, which did not happen, largely due to defense and certain other increases in expenditures, the case would be clear. A growing deficit stains the argument somewhat; one wonders what the economic outcome would have been without the additional government spending. Arguably, the Clinton years and the balanced budget they produced were more indicative of the benefits of Reaganomics than the Reagan years themselves.
The Reaganomics experience showed us all that creative approaches to solving economic problems and aiding prosperity can work. One should be concerned about budget deficits, but one should also not be led to think that tax increases are the best way to close budget gaps. The George W. Bush years (2001–2008) look more like reckless tax policy designed to favor the rich without hope of increasing revenues, and deficits increased widely while the seeds of the Great Recession—too much spending on overinflated assets, and a lax view of risk—were sown. The policies of the Obama administration haven’t been able to touch the rich so much as the president himself would have liked, and new spending has dramatically increased deficits, but there is some evidence that tax revenues are increasing even without major tax rate changes, Perhaps in the next edition of this book we’ll be able to say that Reaganomics and supply-side policies really do work, but for right now, the Reaganomics practiced during the Reagan administration appears to be a much more carefully considered experiment.
What? You’ve got to be kidding. People don’t follow the economic rules? People do things that don’t fit neatly into demand and supply curves? People respond differently to different situations depending on stress, time, and what they see others around them doing?
You bet. And the presence of such “misbehavior” has given rise to a school of economics that combines economics with psychology, behavioral economics. This marriage of two subjects, both hard to research and quantify, has taken center stage in economic thought, as economists and policymakers struggle to fix and avoid economic problems.
Behavioral economics applies social, cognitive, and emotional factors to better understand economic decisions by consumers, borrowers, and investors, and how they affect market prices and behavior. In short, it applies a human factor to decision making, a dose of “psychological realism.” Behavioral economists try to figure out how and why actual behavior differs from rational and even selfish behavior—that is, the lowest cost, lowest risk, or most profitable course of action.
Interest in behavioral economics has increased as a result of the recent mortgage crisis and real estate bubble. Why did so many unsuspecting citizens take on so much debt, so much risk, and so much cost, assuming all along that the real estate market was foolproof? People have been asking such questions for years, dating back to the tulip bulb mania of the early 1600s. But it happens again and again through history. The answer seems to lie somewhere in the “madness of crowds,” or the tendency for people to assume something is right because everyone else is doing it. Moreover, studies indicate that many people jump into these things because they fear being left out; not investing becomes the irrational decision.
In the fall of 2008, the U.S. economy went from an overdose of risk to complete risk avoidance in a matter of months. We went from lending 100 percent of value to a subprime customer to not lending anything at all.
Policymakers have begun to take such factors into account when making policy decisions—although they obviously have a way to go in truly understanding economic behavior, especially in crisis times.
Next time you think about “going along with the crowd,” make sure you’re acting in what economists would call “rational self-interest.” Not all economic or financial decisions can be approached with rigid, mathematical, dollars-and-sense precision; surely your color preference in a car has little to no rational basis. That said, as an individual you are better off for the most part by adhering to economic reality. For society it’s good to know that economists no longer assume that everybody is completely rational; that will lead to less costly policy and to fewer overcorrections in the business and boom-bust cycle. If you want to dig deeper, Dan Ariely’s Predictably Irrational: The Hidden Forces that Shape Our Decisions (Harper Perennial, 2010) is a fascinating read on the subject.
At the height of the Great Depression, with unemployment rates exceeding 25 percent, a broken banking system, and rampant business failures, the newly elected President Franklin D. Roosevelt and his staff developed a complex set of economic programs to deal with these problems. In fact, he called the set of new programs and laws the “New Deal,” and the name stuck. Until 2008, anyway, the New Deal was by far the largest coordinated government effort to deal with the effects of an economic bust; the New Deal was broader in reach, if not as expensive as the economic stimulus and bank bailout programs recently undertaken.
The programs and laws, largely initiated between 1933 and 1935, were aimed at providing economic relief for citizens, and particularly the unemployed, and with the reform of the business practices that gave rise to the bust in the first place. It was really a deal, as it traded off certain kinds of government spending in favor of other programs to revitalize the economy. A balanced budget was a goal, although many economists, particularly from the Keynesian school, maintain that it was a mistake to balance the budget in the depths of a depression.
Roosevelt, his Treasury secretary Henry Morgenthau Jr., and Congress started the New Deal by cutting government spending on military, the post office, general government salaries, and veterans’ payments by a total of about $500 million (the total U.S. budget in 1933 was about $5 billion).
Employment relief came in the form of the Works Progress Administration (WPA) and similar agencies created to provide jobs building public buildings, parks, schools, and roads, which added numerous cultural assets to our landscape. Laws standardizing collective bargaining, providing minimum wages, and eliminating child labor were passed. Social Security (see #50) was part of the New Deal, as were other prominent economic institutions still in place today, such as the Federal Deposit Insurance Corporation (FDIC), the Federal Housing Administration (FHA), the Securities Acts of 1933 and 1934, the Securities and Exchange Commission (SEC), and government-sponsored lending enterprises like Fannie Mae.
The whole point was not just to stimulate the economy but also to provide a fair and predictable base within which it could move forward with a degree of confidence—public confidence as well as confidence between businesses, labor, and government. Many deride the New Deal as tending toward socialism, believing it has left too strong a legacy of government intervention and regulation. Others say the New Deal didn’t go far enough, that it was too conservative, and that we were only bailed out of the Depression by the advent of World War II. What is certain is that the New Deal was enormous in scale and creatively constructed to solve a lot of problems and serve a lot of interests at once. Seldom if ever have we seen a government action or program with this much effect or historical significance.
Not only was the New Deal historically significant as a remedy for the Great Depression—it has also left a legacy of programs that are just as important to today’s economy, if not more so, than they were at the time. The New Deal is also a model for economic remedies being attempted or discussed today, although today’s remedies are larger in scale and less constrained by budgetary considerations.
Mention the idea of a planned economy to almost anyone and you’re likely to get a look of concern in return. Yet during the Great Recession the federal government clearly got more involved in the day-to-day fortunes and operations of the economy—by necessity, some say, or by choice, as others complain.
So, what is a “planned economy,” anyway? And do recent government interventions represent a brush with socialism?
The various levels of “planned economy” that may occur in practice go from “least to most” in terms of planning and control:
Socialism does not fit neatly in this continuum but is regarded as having the broader political and socioeconomic objective of equalizing the distribution of wealth and income. That is accomplished through the means of direct income redistribution policies, central economic planning, and ownership or the formation of cooperatives. The state plans or controls the means of production toward achieving the egalitarian objective.
The interesting debate today is to what degree government actions in the wake of the Great Recession represent a move toward more of a planned economy. Economist and investment company manager Axel Merk, in his book Sustainable Wealth (Wiley, 2009), put it thus:
More than most other world nations, the United States has “walked the walk” of capitalist freedom and self-determinism, although policy at its highest levels has acted as an “invisible hand” and to “lean against the wind” to move toward politically acceptable economic outcomes. But in the aftermath of the credit crisis that hand has started to become more visible. The fear is, of course, that once that process gets started, once trust is replaced by government intervention, it can spin out of control; the world has ample experience with the iron hands of socialism and communism.
As the credit crisis was dealt with, major sectors of the economy—the financial industry, the auto industry—effectively became wards of the state. They became dependent on the U.S. government for financial sustenance and even for leadership through the crisis. The state went further into the private economy by granting credit to specific industries and businesses, something which had almost never happened before, certainly not on such a large scale, in U.S. history. It was, in short, a brush with a planned economy.
Merk goes on to argue that a severe recession “ought to be the lesser evil than a planned economy,” and while we are still a far cry from communism, we “must keep our eyes open and not be blinded by the perceived ‘help’ of money printed by the Fed.”
It’s important to understand today’s economic actions and reactions, and those observed before, during, and after the Great Recession, in the context of government influence and control. Whatever your philosophy and acceptance or rejection of this intervention, you should understand how it fits into the greater context.