I no longer find economics as compelling as I did when I encountered it in high school. At first, it seemed like a secret key for understanding the world. The elegant graphs and the step-by-step logic of supply and demand made a lot of intuitive sense.
But over the years I have observed that life doesn’t always confirm economic theory. After the 2008 economic crisis, it seemed obvious that dumping large amounts of money through deficit spending and devaluing the currency would lead to inflation. But it never really happened. There was modest inflation, but not nearly as much as one expected based on the big spending and low interest rates put in place during 2009 and 2010.
Then, more recently, with the COVID lockdowns and massive decline in economic activity, one would have expected a long and deep recession. While we did have a sharp drop in 2020, we had an equally swift recovery. Not only the stock market, but employment and consumer spending recovered and then some.
Along the way, new problems emerged: workers became hard to retain (a problem or a good thing depending on one’s point of view), various shortages appeared for essential goods, and prices skyrocketed for real estate, gas, and other goods.
COVID Spending Spree
In response to COVID, the Paycheck Protection Program (PPP) Loans and stimulus payments were totally unprecedented in scale and scope. These programs were an order of magnitude larger than the response to the 2008 economic crisis, and the money went not only to shore up the balance sheets of the banks, but to individuals and small businesses. In the process, the money supply quintupled. It seemed some kind of inflation was inevitable. Of course, it seemed that way in 2008 too, but the scale of spending then was lower, and the rot in the economy was deeper and more widespread.
Life, economics, and public policy are complicated affairs, and economists disagree about a great deal. I always found the Austrians the most persuasive, especially their theory of the business cycle and recessions. Austrians describe the business cycle as a product of monetary policy, specifically, loose monetary policy. When this happens, economic signals are distorted, and objectively bad investments appear attractive. When reality catches up, the economy contracts, as the unprofitable investments are revealed.
Classical economics, and particularly the dominant approach of John Maynard Keynes, presents a different theory. For them, the business cycle just happens. It doesn’t have any particular reason. For Keynesians, the solution always is more government: in good times the government should raise taxes and reduce spending to curb inflation, and during recessions it should deficit spend in order to increase demand. For obvious reasons, politicians have gravitated to this theory, which enhances their power.
Monetarists (including Milton Friedman), do not necessarily disagree with Keynesians, but they believe an overly tight monetary policy, particularly during bad economic times, creates a “crisis of liquidity,” turning mild downturns into disasters. This is one of their explanations of the Great Depression. This account is also widely accepted by Keynesians, who add the parallel explanation that demand collapsed during the 1930s and a recovery happened because of unprecedented government spending.
Stagflation Provides a Challenge to Policy Makers
Both of these mainstream theories have some trouble explaining the phenomenon of “stagflation,” which became endemic in the late 1970s and is now appearing again. With both inflation and demand collapse happening at the same time, dealing with one problem using the traditional tools (adjusting spending or interest rates) will make the other worse.
Under the leadership of Federal Reserve Chairman Paul Volcker, monetarists advocated addressing the inflation problem through a massive increase in interest rates. In other words, they prioritized fighting inflation over unemployment and succeeded. But this came at a great cost, leading to a very deep recession through 1982.
The same monetarist theory gave Fed Chairman Ben Bernanke the nickname “Helicopter Ben.” During his tenure (2006-2014), he was more concerned with recessions and the theory counsels massive devaluation of the currency by handing out money to all and sundry during slowdowns, as if it were dropped from a helicopter.
This is one reason we are where we are today with inflation. Everyone is a monetarist now, even though their track records leave something to be desired. For example, in 1933 FDR did massively devalue the currency, de facto ending the gold standard and also increased spending through a variety of novel programs, but the Great Depression still lasted nearly a decade, reaching its deepest depths in 1937. Even under the monetarist regime dominant at the Fed since the early 1980s, there have been several recessions, including the massive one in 2008.
In their strenuous attempts to avoid a “liquidity crisis,” inflation has now returned again, and the economy is also contracting. Monetarist theories, whatever their merits, also face certain institutional headwinds, including the desire of political decision makers to delay a reckoning and avoid tackling inflation rather than risk even the mildest economic slowdown.
Thus, since 2008, interest rates have barely budged.
Stimulating the Stimulated Economy of 2021
Some kind of stimulus and expansion of liquidity may have been the right approach at the start of the COVID episode, but Biden has only accelerated spending since entering office, encouraging massive stimulus and infrastructure packages, even as the economy was already showing signs of overheating at the end of 2020. There was little explanation at the time as to why these expensive and unfunded programs were necessary.
This brings us to the present. There is now massive and sustained inflation. And the Federal Reserve and the Biden Administration have been slow to acknowledge the problem. Jen Psaki mocked inflation and supply chain problems, suggesting they only affected the rich and might delay their Peloton orders. Janet Yellen, the current Treasury Secretary and former Federal Reserve Chairman, repeatedly downplayed inflation over the last year, calling it “transitory.” Well, it’s proven anything but.
Even as inflation is expanding, we are also experiencing a contraction of the economy. The terrible stagflation mostly avoided since the late 1970s has returned. And once again it is enhanced by the deindustrialization of the American economy, and the now much larger burden of debt—government and personal.
Much like the Carter years, there is absolutely no sense that the Biden Administration or really anyone has a great idea regarding what to do about all of this. Biden—as well as his treasury secretary—denied the problem until it was undeniable. They’ve now turned to blaming Putin and even the American people, as if the government’s large spending programs, anti-energy policies, and the Fed’s sustained and artificially low interest rates did not create our current circumstances. It is telling that Biden’s expensive “Build Back Better” agenda is now being touted as an inflation-fighting measure, which makes no sense, since it involves a massive expansion of government spending and was initially sold as part of a stimulus package.
While I am more agnostic these days about definitive economics predictions, the notion that the government can behave the opposite of a responsible individual or company—for example, by spending with abandon when times are bad—seems to be both counterintuitive and explanatory of the meager results of central banking policy and various government stimulus programs.
Just as individuals need to tighten their belts and distinguish needs from wants during bad times and save for a rainy day during good times, governments also benefit from fiscal responsibility. Tackling the deficit by reducing government spending, running surpluses, and getting the American fiscal house in order would strengthen the dollar, thus reducing nominal prices and freeing up more money for private investment. Normal, market-based interest rates, which rise during good times, would prevent a recurrence of the last several decades’ track record of multiple bubbles and malinvestment.
This is all very unlikely, of course. It would take courage and responsible, forward-looking leadership. Instead, we now appear to be in the “looting the treasury” phase of our decline, to the point where in the midst of an exploding debt and inflation problem, $40 billion worth of arms and money we cannot afford to give away is nevertheless being sent to Ukraine.
Economics seems right some of the time and confused in others. As with any field of human inquiry, there is also a lot of disagreement among the experts. But it’s worth remembering that everything that has happened recently—the 2008 recession and the current inflationary episodes—happened at the hands of the experts. Indeed political decision makers handed the keys over to them, supporting the TARP giveaway and then, more recently, PPP and a massive expansion of the money supply. If everything undertaken in the last few years worked, then the same policies should not have resulted in the economic crash and anemic recovery after 2008.
There seems little reason to think we will avoid something equally bad this time, now with the added misery of widespread inflation.