Steven Hales

The Economic Policies of Failure

"The greatest limitation set in place is the inability of the economy to deflate"

Well, the Great Contraction between 1929 and 1933 was the greatest deflation in our history, so are you in favor of a deflation? Let the velocity of money decline while the money supply falls and you have a huge contraction in output. This is something to be wished for?

Recessions are part of the business cycle which has an unknown or unknowable periodicity. There is contraction in output during recessions and weaker companies fail. This is a good thing.

The circuit breakers that are in place from unemployment insurance to social security prevent demand from falling off a cliff in a recession. This is a good thing. It allows breathing room for inventories to be reduced and capicity utilization to fall. Until confidence returns as marginal demand increases the economy is resting on a floor of demand created by the circuit breakers.

All economies at all periods in history have been subject to the liquidity preference whether they were aware of it or not. The Spanish economy collapsed in the 16th and 17th centuries as its money supply shot up from gold discoveries in the new world. The situation was so dire that Spain tried to invade both England and the Netherlands. The Spanish wool trade had collapsed because of domestic inflation, Spanish wool became too expensive as measured in bullion.

We are not 16th century Spain. Our money supply as measured by M2 has remained a fairly constant percentage of total output (GDP) in other words inflation is contained. Exogenous factors like commodity price hikes or speculative investing are not under the direct control of central banks. Recently the monetary base has increased largely because velocity has decreased threatening a severe contraction in output. The FED has responded reasonably to the threat of deflation. The lessons of the Great Contraction have been learned very well. And the economy is not deflating. This is a good thing.

If you are calling the circuit breakers "keynesian" then so be it. But recognize them for what they are an economic floor. They do distort the depth of the business cycle but they do not abolish it.

Liquidity is and always has been the lifeblood of economies. Our fractional reserve banking system is the most efficient means yet invented to ensure that money supply expands in tandem with output. This is not Keynesian or Moneterist it is simply observations of how economies function put into formal practice. We could go back to Herbert Hoover or even further before the Federal Reserve Act, but do we want to?