Monday, 16 April 2018

Millions to become unemployed just because politicians know nothing about economics.

As this Brookings Institution article  rightly says, come the next recession, the Fed may have limited scope for cutting interest rates because they are already very low, and fiscal stimulus may be limited because politicians are worried about the debt and the interest paid on it. Indeed, that happened to some extent in the recent recession. (Title of Brookings article: "Tax and spending legislation disarms us against next recession.")

So what are those pig ignorant politicians (and quite a few pig ignorant economists) worried about? Well first it might seem that as the debt rises, so too will the rate of interest paid on the debt. But that’s unlikely because assuming stimulus really is needed and assuming the Fed recognises that, then the Fed will stop any such interest rate rises by printing money and buying up government debt. Indeed, there’s nothing to stop the Fed cutting interest rates to zero or very near zero. So that’s the alleged “interest on the debt” problem solved.

But politicians will doubtless have another worry: what happens to interest on the debt when the recession is past, and the debt is significantly bigger? Well if debt holders are happy to continue holding debt at a relatively low or near zero rate of interest, then there isn't a problem.

On the other hand, if they start demanding a significantly higher rate, then all the Fed needs to do is to print money and pay off debt holders as debt matures, and tell debt holders to get lost. Of course that money printing could be too inflationary. But that’s not a problem in principle: the Fed just needs to tell politicians to raise taxes or cut public spending with the Fed “unprinting” the money collected or saved.

Note that the latter strategy would have NO EFFECT on demand or numbers employed, strange to relate. That is, while raising taxes normally cuts demand, the purpose of the cut in demand here is simply to keep demand down to a level where it does not cause excess inflation. In other words, in real terms, there would probably be no effect on demand at all.

Unfortunately that’s not the way politicians or voters would see it. Politicians would balk at the latter tax increase. Thus politicians’ ignorance about economics would scupper the latter strategy. And as a result, the above mentioned fiscal stimulus may well not be implemented at all.

Ultimate effect: millions become unemployed because of politicians’ ignorance about economics. And if that isn't a catastrophically stupid way to run a railroad, I don’t know what is.

The solution, as advocated by Positive Money the UK based economics think tank, is to separate politics from economics. That is, have politicians take strictly POLITICAL decisions, like what percent of GDP to allocate to public spending and how that is split between education, defence, etc), while decisions on the size of stimulus packages are taken by economists.


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