Those Who Do Not Learn Economic History Are Doomed To Repeat It

That was my proposed headline, but the editor thought the headline needed less Santayana (and fewer verbs.)

WHY FEDERAL BUDGET IS NOT LIKE YOUR FAMILY FINANCES
East Valley Tribune, Oct. 19, 2008

With the recession already here, remember: Countries are not like people. Their budgets should work differently.

I thought we’d settled this argument in 1971 when Richard Nixon said “We are all Keynesians now.” But with the Republican Party becoming more extreme each year, what Nixon believed is apparently liberal heresy today.

John Maynard Keynes first noted that consumers and businesses, making rational individual decisions, could lead to less-than-optimum results for the overall economy. Keynes concluded that an economy could reach equilibrium at less than full employment, with insufficient aggregate demand resulting in higher unemployment and lower output than necessary.

Keynes saw two ways that government could help boost aggregate demand during slumps, monetary and fiscal policy. In the former, lower interest rates would make borrowing cheaper and encourage businesses to borrow and invest. For the latter, governments could invest in infrastructure, with a “multiplier” effect as spending creates construction jobs, giving more people income to buy things, which creates retail jobs, and so forth.

If the economy is heading for a recession, you’d lower interest rates and increase government spending. The opposite is true during a boom; to keep things from getting out of control, the government should raise interest rates, spend less, or raise taxes during good times to prevent asset bubbles and inflation. We forgot to be countercyclical on the way up -- but that’s no reason to forget on the way down.

Some ‘wingers still pretend to believe in supply-side economics, that lower tax rates somehow raises revenues. Even the Bush administration doesn’t believe that fairy tale anymore. And for the past 15 years, the economy acted exactly the opposite as supply-siders claimed. We raised taxes in 1993, and the economy boomed; George W. Bush’s 10-year tax cuts are still phasing in, and the economy is in recession. And even supply-siders believe in the economic multiplier effect of a Super Bowl; why wouldn’t something permanent, like a new university building or transit system, have the same, if not greater, multiplier effect?

During a recession, what should individuals do? Spend less, save more. It makes sense for individuals, but what if you’re a retail business, and your customers cut back? Last week, the Census Bureau announced preliminary September retail sales figures, which dropped 1.2 percent from August, and 4.3 percent in real terms from the previous year. In an economy dependent on consumer spending, consumers are spending less. It makes sense for individuals, but it’s bad in the aggregate.

What should businesses do? Sequoia Capital, a venture capital firm in Silicon Valley, summoned the CEOs of the businesses in which Sequoia invested; the only previous mandatory meeting was for during the dot.com bust. The companies were instructed to fire employees, reduce spending, curb investment, and cut salaries. Which is perfectly rational for each company, but means not only are consumers spending less, so are businesses -- and that’s even if they could get loans in the credit crunch.

We can’t expect lower interest rates to do much; official rates are historically low, and recent Federal Reserve moves haven’t resulted in spurring lending, because the banks are as scared of each other and the overall economy as are consumers and businesses. Again, it’s rational individual decisions leading to bad overall results.

The only cavalry that could ride over this gloomy event horizon is the government. Unless you want a really long recession, you should stop fretting about budget deficits. States and cities are cutting back; they have to have balanced budgets. Consumers and businesses are cutting back; they’re scared. You could cut their taxes, and they’d be too scared to spend.

We once had a president who, faced with a recession and loss of faith in the economy, had the government do the individually responsible thing. He cut spending, increased revenues to eliminate a deficit, and looked for voluntary efforts to bring the economy around. His name was Herbert Hoover.

So whenever you hear the government-should-act-like-a-family-budget analogy, remember: That’s Herbert Hoover talking! Your grandparents tried it, and they didn’t like it.