Tuesday, 16 July 2013
DeLong and Mankiw try to defend monetary policy.
I’ve put DeLong's words in colour.
In this article he claims . . .
“The principal argument for monetary policy is that, by modifying asset supplies and thus asset prices, it induces households and businesses to boost their spending on things that they almost bought anyway. Thus–for marginal policy shifts, starting out at a first-best optimum, and if the relative distribution of wealth corresponds to social welfare (or if questions of the relative distribution of wealth are left to a more openly political process and walled-off from technocratic macroeconomic questions of stabilization policy)–monetary policy will not push you far away from the free-market optimum."
The answer to that is that given the VAST AMOUNTS borrowed by governments, and the attempts to reduce the interest raising effects of that by having central banks buy back almost equally vast amounts of debt, it is very hard to say what the “free-market” rate of interest would be, absent the government bull in a china shop.
But let’s assume that the bull in the china shop does permanently raise or lower interest rates.
Come a recession, governments try to effect an ADDITIONAL distortion: they implement interest rate cuts and/or QE. But that distortion is unwound come the recovery. The result is that the economy is distorted towards the production of investment items: a distortion which has to be unwound come the recovery. And that policy involves obvious inefficiencies: e.g. trying to shift labour to investment related activities and back again, come the recovery.
DeLong continues . . .
“Fiscal policy, by contrast, works through expanded government purchases ΔG.”
No it doesn’t: it works through EITHER “expanded government purchases” AND/OR tax cuts (i.e. expanded private purchases).
DeLong continues . . .
“These must be financed by distortionary taxes to amortize the debt in the future. These taxes do drive a wedge between the social and the private values of output in the future. And what the government buys is determined by a political rather than by an optimizing economic logic”.
The answer to that is that taxes do not have to be distortionary. For example a uniform sales tax on ALL ITEMS purchased by households would not be distortionary: it would not change the RELATIVE PRICE of the various items purchased by households.
As to deLong’s objections to the shape of the economy being determined by “political rather than optimising economic logic”, the assumption that an unfettered free market brings some sort of flawless or “optimum” or quasi nirvana type society is plain bizarre. That is a society in which no taxes are collected to fund the maintenance of law and order, so you’d get anarchy, or something of the sort.
It would be a society which collected no taxes to fund defence and which thus made no attempt to defend itself against foreign aggressors. Not even the most right wing pro-free-market Republican would approve of that. It would be a society in which the children of the feckless were not taught to read and write. That doesn’t sound like “optimum” to me (which is not to deny there is a fair amount of waste and distortion resulting from government activity).
Monetary policy distorts, whereas fiscal policy does not necessarily distort. And even where fiscal policy DOES DISTORT, that is not necessarily wrong: the latter distortions result from decisions taken by democratically elected governments – decisions taken because it is the view of such governments and electorates that we’re all better off if “political logic” overrides “economic logic”.