Thursday, February 26, 2009

If They Are Both Right, We're Screwed

The 1.5 trillion dollar question (or whatever we're up to now) in Economics is: who is right...Friedman or Keynes.  Is spending money going to break a brutal self-reinforcing downward spiral of economic contraction, or just waste so much future production that we'll have another "lost decade"?

The Friedmaniacs would say the Keynutjobs* will cause stagflation - if we spend a huge amount of money in a way that isn't efficiently allocated, that claim on future production is a weight around our neck.  (That is, we just don't have a trillion dollars to spend, and when the stimulus is over, we still won't.)

The Keynutjobs would say the Friedmaniacs don't have a tool to increase demand - management only from the supply side is incapable of dealing with a self-reinforcing drop in aggregate demand.  (That is, lowering taxes and interest rates does no good if we are all too scared to shop.)

What if they're both right?  Each camp describes a real weakness of the other's, and these weaknesses have been seen in practice at times of extreme dislocation.

What if there is no middle-ground.  What if there is no spending pattern large enough to break a cycle of decreasing output that won't also have long term fiscal repercussions?  Then we're really screwed.

(My gut feeling is that we're screwed by design.  A stimulus package, if it is going to have the psychological effect of convincing people that we aren't in deep doodoo, has to be absurdly big. That is, markets get built in expectations, and if they expect too much, you have to really clock them on the head.  But the political process is only going to take a huge package and make it even bigger.  So what can Obama do?  If he intentionally low-balls the stimulus in an attempt to counter-act all the pork that gets added on, the market immediately gives him a vote of no confidence, and then any super-sizing of the package has to be even bigger.)

* I found the term "Friedmaniacs" somewhere on the web...I think it has a bit more ring than Keynut-jobs, which I just made up now, having not found any good derogatory terms for Keynsianism after 2 minutes of Google.  I think there are ideologues in both camps that take a single policy to enough of an extreme to warrant a goofy name.