Friday, January 29, 2010

Maddow on the Spending Freeze, Continued . . .

The exchange between Rachel Maddow and Jared Bernstein is still bothering me, so I thought I'd offer some additional comments.



First, while I understand that Maddow is a strong-minded progressive, it's infuriating to hear someone -- even a left-wing television host -- assert the correctness of Keynesian theory without even acknowledging the opposition.

If Maddow had suggested that "many economists believe" that the Roosevelt Recession of 1937 and the Japanese Lost Decade were the result of contractionary fiscal policy, she would've been on much sounder footing. But Maddow didn't qualify her statements at all.

This kind of provincial thinking is exactly the reason liberals criticize conservative pundits, who seem unable to accept that there are often many legitimate views when it comes to complex economic problems. But for some on the left, fiscal stimulus seems to have become the liberal substitute for conservative tax-cutting ideology.

Second, Maddow's interpretation of both these events is, at best, extremely narrow-minded.

A more nuanced reading of the Japanese crisis provides a dramatically different story of the potential problems with a poorly-designed fiscal stimulus package:

For many, the moral of the story isn't that Japan erred in deciding to use fiscal policy to fix their economy -- its failure was in the execution.

For one thing, there was dubious logic behind too many of Japan's infrastructure projects. "It was the epitome of bridges to nowhere," says economist Ed Lincoln, director of the Center for Japan-U.S. Business and Economic Studies at New York University. "There was apparently a $2 billion bridge built to an island of 800 people."

. . .

Lincoln adds that at its peak in the 1990s, the government was spending 8% of GDP on public works projects. By comparison, the United States now spends about 3% - even several hundred billion dollars in proposed projects would not get the United States to Japan's peak.

. . .

Finally, any action by the government needs to be done swiftly and decisively.

The Japanese government's efforts were spread over several years but it was as if its leaders couldn't pick one strategy and stick to it. After passing a series of stimulus packages in the early 1990s, the economy showed signs of improving; by 1995, GDP was growing at roughly an annual rate of 2.5%.

And then the government took a fateful step. Worried about its growing debt, Japan raised its consumption tax two percentage points, to 5%, in 1997. And the economy, by now also hobbled with deflation, sunk into a recession.

"When you look at the Japanese crisis, you really don't see the drama of a collapsing economy and a big contraction of the economy and sharp increase in unemployment," says Reinhart. "What you see is this lingering malaise in which a very rapidly growing, buoyant economy becomes one that's limping along."

The trouble with any debate over Japan's stimulus in the 1990s is that it's impossible to know what would've happened if the government had taken lesser action. Many argue the situation would've been worse.

One thing is certain: Japan still faces a mountain of debt from all its spending; debt is now around 200% of GDP, vs. 45% for the U.S. And the U.S. can count on a similar situation if it embarks on more big-government spending.

In the end, though, looking to history can yield only so many lessons. Very few other countries have faced a comparable crisis followed by a huge government stimulus, and Japan is only one scenario. "I think it is extremely dangerous...to draw large lessons from one observation," says Reinhart. "Using the Japan example to make a bold statement about whether stimulus packages work or not I think is on very shaky ground."

Interpreting the cause of the Roosevelt Recession is an equally complicated business, and there are a number of different theories. Many economists attribute the rapid decline in 1937 to a contraction of the money supply, in addition to Roosevelt's dramatic reductions in the deficit spending. This was Milton Friedman's view of the problem, and those who took an introductory macroeconomics class may also remember that he wrote a whole book criticizing the Keynesian interpretation of the Great Depression.

Either way, Obama's proposed spending freeze -- which targets only non-defense discretionary funds, and is specifically designed to avoid impacting jobs -- is not remotely comparable to Roosevelt's large-scale reversal in federal spending, including vast reductions in funding to the WPA and other public works agencies.

Even some on the left have been savvy enough to criticise Maddow's faulty analogy. The more I watch Rachel Maddow, the more frustrated I become with her apparent lack of consideration for the other side.

1 comment:

JonCatalán said...

If you're interested, I wrote a piece on the recession of 1937 for Mises Daily, available here: http://mises.org/daily/4039

While I originally sought to argue that the Monetarist theory of monetary contraction could be reconciled with the Austrian theory of the business cycle, I found out that this opinion was wrong. In the above linked article, I write:

"The 1937 recession came with a contraction in the money supply. The reasons for this contraction is that the Federal Reserve raised the reserve ratio in the previous months.[7] However, his explanation of the contraction is unsatisfying, because the volume of loans made and securities sold continued to rise despite the increase in the required reserve ratio. It was only after the initial fall in the stock market that bank lending began to tighten.[8]"