Voodoo economics don’t hold water

Keynesian ideas are politically convenient, but they don’t spur recovery

By Geoffrey Lawrence
  • Thursday, May 21, 2009

On Monday, Mark Zandi, a chief economist at a website division of Moody's Analytics, addressed a group of Las Vegas conventioneers and told them that pervasive government intervention into the marketplace — through record spending, artificial money creation, high taxes and indebtedness — will be a boon to the economy and will cause the recession to end by October. 

It's too bad the Keynesian ideas expressed by Mr. Zandi have never worked despite the many times they have been put into practice.

What Mr. Zandi and others of like mind fail to see is that heavy government intervention was the cause of — and not the cure for — the current recession. For nearly two decades, the Federal Reserve has rapidly injected new money into the American financial system in order to artificially suppress interest rates. This expansive monetary policy led to spending across the economy that was based on artificial credit instead of savings. As a result, there was a tremendous over-investment across the country into sectors of the economy that would not have seen such high levels of investment without monetary manipulation by the Fed.

This form of government intervention is precisely the process that leads to the creation of "bubble" markets, such as seen most recently in real estate development. These bubbles are created by government because a temporary jump in the rate of economic activity, even if unsustainable, tends to make politicians look good. The bubbles inevitably burst when individuals begin realizing that their investments have been grossly out of line with savings rates.  The recession that ensues regularly is as pronounced as the preceding artificial boom — as the misallocation of resources that the Fed prompted in the economy is corrected.

Keynesian economists such as Mr. Zandi attempt to prevent this correction from occurring by imposing an even more burdensome and encroaching set of "voodoo" economic policies that explicitly aim at handicapping the market's ability to self-correct. They regularly claim that governmental authorities should ramp up government spending through high taxation and the printing of even more new money. The "economic stimulus" that they hope for government to provide is nothing more than an effort to ensure that the national economy will remain on its misdirected path and will not return to economic fundamentals. Hence, when Mr. Zandi claims that the "economic stimulus" will lead the nation out of recession by October, what he really means is that normal market function will be completely debilitated by October.

Politicians, of course, regularly avail themselves of the "voodoo" economic policies suggested by Keynesians, since those suggestions give them a rationale to spend as much as they want on virtually anything they want. However, because Keynesian policies seek to avoid the necessary market adjustment that would return the economy to sound fundamentals, they wind up delaying recovery and prolonging economic recession. This has been seen time and again, with the most prominent examples coming in the 1930s and 1970s. 

In spite of the fact that Mr. Zandi is quoted saying, "The reason why we suffered a Great Depression in the 1930s is because there was no policy response," history indicates a very different story. First, the Hoover Administration recklessly ramped up public expenditures in order to prevent the market from adjusting to a Fed-induced bubble by commissioning a series of government work projects such as the nearby Hoover Dam. In Hoover's four years in office, federal expenditures increased 49 percent. The Roosevelt Administration then built on that tradition by growing federal expenditures by an additional 106 percent by the end of the decade.  The result was to stretch a government-induced recession into a government-prolonged Great Depression.

The process of creating recessions through monetary policy described here is known in economics as the "Austrian Business Cycle." It is the only cogent theory that explains why business cycles repeatedly occur. The development of this theory won Friedrich von Hayek the Nobel Prize in economics. Other prominent scholars who have contributed to the theory include Ludwig von Mises and UNLV's Murray Rothbard. 

While Keynesians generally abhor the theory because it invalidates all of their conclusions, they have never been able to refute the theory. Because of their inability to refute the theory on any merits, many Keynesians have smugly dismissed it as "Neanderthal economics," while hiding behind Ivy League credentials to disguise their ineptitude. Yet, apparently prestigious credentials do not overcome empirical evidence combined with sound, substantiated theory.

In truth, what eludes these "voodoo economists" is self-evident to the great majority of individuals. That is, that spending is wisest when based upon savings, not artificial credit. 

The extent of government growth and spending lauded by Mr. Zandi will not expedite economic recovery. It will have the opposite effect. 

Politicians who try to "save us" by spending us into the ground are only laying the foundation for national bankruptcy on a third-world level.

Geoffrey Lawrence is a fiscal policy analyst at the Nevada Policy Research Institute.

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