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Tuesday, June 28, 2005

The School of “Hairshirt” Economics

Christopher Farrell of BusinessWeek Online creates some new (and confusing) schools of economic thought - the hairshirts and the Growth proponents:

Alan Greenspan, Wizard or Villian (sic)?, By Christopher Farrell, BusinessWeek Online:  Remember when Federal Reserve Board Chairman Alan Greenspan held sway over the American economy -- and imagination? … No more. Greenspan-bashing is now a popular sport ... One reason is that the 10-year economic expansion came to an end with the dot-com bust and subsequent recession. Another is that Greenspan's standing as the Monetary Maestro was overhyped during ... the 1990s. And the third is that his fallibility as a central banker was overemphasized during the difficult economy of the early 2000s. Indeed, the chairman has never recovered his lost luster.

No mention of his support for the 2001 tax cuts?

Still, Greenspan's most vehement critics go a lot further than this. They're convinced he has made a fundamental error as a monetary economist. Call it the hairshirt economists vs. the cheerleaders for growth-is-good. The hairshirts believe that for the health of the economy to be restored, the inevitable bust that follows a boom must be at least as great as the boom. Growth proponents -- and there's none greater than Greenspan -- believe that it's better to limit the fallout of a bust and get the economy growing again as quickly as possible.

Hairshirt economists?  What school is that?  Though he makes reference to Schumpeter's evolutionary view of cycles (recesssions are good because they weed out the inefficient firms and workers) later it becomes evident he means classical economists, so why not just say that?  And the Growth proponents – most of us would call them Keynesians.  More on this shortly, but there are two fundamental confusions here.  The first is to call the monetarists interventionists.  The second is to confuse short-run stabilization policy with policies to promote long-run growth.

… To the hairshirts' way of thinking, the great mistake Greenspan made was … to drive rates to a 45-year low to limit the damage from the recession. The Fed then nurtured the recovery by keeping money policy loose …  The result: today's "low saving rates, the housing bubble, high debt loads, and a runaway current account deficit," writes Stephen Roach, chief economist at Morgan Stanley … The critics say Greenspan has transformed the economy into a giant bubble ... The longer he delays the day of reckoning, the worse the fallout will be when the bubble pops.  That's a severe indictment -- but not necessarily a valid one. A problem with the anti-Greenspan mindset is that hairshirt economics was largely discredited during the Great Depression. The most infamous proponent … was Andrew Mellon, President Herbert Hoover's Treasury Secretary. He called for letting the Depression run its course without government interference …

In case you missed it, that’s an endorsement of Keynesian economics and a claim that the Great depression invalidated classical economic policy (the monetarist, hands-off, laissez faire position), as he now notes

… Mainstream economists of all schools, from Keynesianism to monetarism, turned away from hairshirt economics after the Great Depression. They realized that the government could play a positive role in counteracting contractionary forces in the economy. …

This is really confused.  How did Keynesians turn away from hairshirtism after the Great Depression?  Keynesian economics didn’t even exist prior to the depression.  What he’s trying to say is that the forced interventionist experiment caused by World War II was credited with ending the Great Depression leading to an endorsement of Keynesian economics over the classical hands-off position.  And it’s just wrong to say that monetarists advocated government intervention.  There was this long discussion, called the Keynesian-Monetary debate, on this issue.

… Case in point: The chairmanan (sic) came under heavy criticism during the 1990s for not "taking the punchbowl away" ... The fear among most economists was that inflation would take off as the economy heated up. But Greenspan gambled … The bet paid off handsomely.  American productivity has been running at an average annual rate of 3% since 1995, about double the pace of the previous two decades. Productivity is what economists really care about, because its growth rate is the foundation of higher living standards.  … Indeed, most economists systematically overestimate the limits to growth …

This is another fundamental misunderstanding.  There are two distinct sets of economic policies, one set is about stabilizing the economy around the natural rate, whatever it might be, the other is about making economic growth as strong as possible.  Long-run economic growth depends upon real,  not monetary factors in almost all mainstream economic models.  Monetary policy is designed to stabilize the economy around the natural rate, but it does not change the natural rate itself.  Technology, growth in human and physical capital, growth in the labor force, etc. are the sources of growth.  Monetary policy is not a large factor.  It affects growth in the short-run, but not the long-run.

… Perhaps there is a bubble in the housing market. … But a record 70% of American households now own their own homes. And growth is also persuading business leaders to invest … Greenspan is no economic wizard … He has made his share of mistakes ... But what should be defended is the economics of growth. Remember, not all price increases are bubbles, booms are better than busts, and growth is not only good -- it's vital.

So, Greenspan is a monetarist interventionist Growth proponent following Keynesian short-run policies to promote long-run growth. 

Hare-brained hairshirt economics.

[PGL at Angry Bear comments here.]

    Posted by on Tuesday, June 28, 2005 at 03:42 PM in Economics, Monetary Policy, Press | Permalink  TrackBack (1)  Comments (12)

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