Sunday, 21 August 2016

Helicoptering equals the free market’s cure for recessions.

In a perfectly functioning free market, and given a recession, wages and prices would fall, which would increase the real value of money (base money to be exact). That would encourage spending which would cure the recession. That’s known as the Pigou effect.

Unfortunately in the real world, wages are sticky downwards (to use Keynes’s phrase) thus the free market’s cure doesn’t work too well. However, it can be imitated simply creating and spending extra base money into the economy (helicoptering). That comes to the same thing as the free market cure for a recession. (Incidentally “QE for the people” is another name for helicoptering).

In contrast, while interest rates would doubtless fall in a recession given a free market, there is nothing much to stop them falling in the real world. There is thus little reason to think that additional and ARTIFICIAL attempts to cut interest rates engineered by central banks resemble the free market’s cure for recessions.

Indeed, there are obvious anomalies with interest rate cuts. First, any increased demand resulting from such cuts is concentrated in the capital goods sector of the economy, and that means more dislocation than if the increase in demand is spread more widely thru the economy (as occurs under the free market’s cure for recessions). Second, recessions are not necessarily caused by a decline in demand for capital goods: they can be caused by a decline in consumer confidence, i.e. a decline in demand for consumer goods. Third, even if a recession IS CAUSED by a decline in demand for capital goods, the assumption that that decline should be made good is questionable.

A classic example of that was the decline in demand for housing / property which sparked off the 2007/8 recession. That in turn was caused by the irresponsible lending (particularly in the US) which preceded the recession. Now the idea that the best cure for a recession sparked off by irresponsible lending is to encourage more lending is stark, staring, raving bonkers. It’s LUNATIC.

Yup. The emperors running the show really don’t have any clothes.

The only possible problem with helicoptering comes when it needs to be reversed. Certainly things are more complicated there than in the case of an interest rate hike. However, the fact that some measure is easy for the authorities to implement is not a brilliant argument for it if that measure does not actually have much effect: and the evidence seems to be that interest rate adjustments do not actually have much effect.

Second, if an extra thousand bureaucrats are needed in a country like the UK (with a population of about 60 million) to manage reversing QE for the people, that is a complete irrelevance in the total scheme of things.

Reverse helicoptering.

As mentioned above, reverse helicoptering has potential problems. Altering sales taxes like VAT doesn’t seem to be too difficult: the UK cut and then increased VAT during the recent recession.

Putting a stop to new orders for government purchased stuff would not be difficult either. On the other hand cutting the state pension or unemployment benefit obviously involves potential political problems.

So I suggest the optimum policy is to use helicoptering as far as possible, while only using interest rate adjustments to the extent that helicopter adjustments prove too difficult.

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