Friday, October 14, 2011

WHY IS OUR ECONOMY FAILING?

Rosie on the Right

When Rahm Emmanuel said “never let a good crisis go to waste?” last August, I wondered “ ”What if Keynesian stimulus works, but no one can ever actually afford to do it, short of something like World War II, where the government can tap into a patriotic outpouring of national savings by issuing bonds with negative real yields.” To properly explain what I am talking about I am going to have to explain the Keynesian economic theory. This is the wikipedia defenition:
Keynesianism and Keynesian theory is a school of macroeconomic thought based on the ideas of 20th-century English economist John Maynard Keynes.
Keynesian economics argues that private sector decisions sometimes lead to inefficient macroeconomic outcomes and, therefore, advocates active policy responses by the public sector, including monetary policy actions by the central bank and fiscal policy actions by the government to stabilize output over the business cycle.[1] The theories forming the basis of Keynesian economics were first presented in The General Theory of Employment, Interest and Money, published in 1936. The interpretations of Keynes are contentious and several schools of thought claim his legacy.
Keynesian economics advocates a mixed economy — predominantly private sector, but with a significant role of government and public sector — and served as the economic model during the later part of the Great DepressionWorld War II, and the post-war economic expansion (1945–1973), though it lost some influence following the stagflation of the 1970s. The advent of the global financial crisis in 2007 has caused a resurgence in Keynesian thought.[2]
Here it is in a nutshell:
John Maynard Keynes known as "the father of modern economics." 
believed the classical economic policies of non-intervention
would not work. The economy would need prodding if it was to head in the right direction, and this meant active intervention by the government to
manage the level of demand. He didn't have the same confidence in the labor market as Classical economists. He argued that workers would not be happy about taking wage cuts and would resist this. This would mean that wages would not necessarily fall enough to clear the market and unemployment would linger.
Keynes explanations of slumps ran something like this: in a normal economy, there is a high level of employment, and everyone is spending their earnings as usual. This means there is a circular flow of money in the economy, as my spending becomes part of your earnings, and your spending becomes part of my earnings. But suppose something happens to shake consumer confidence in the economy. Worried consumers may then try to weather the coming economic hardship by saving their money. But because my spending is part of your earnings, my decision to hoard money makes things worse for you. And you, responding to your own difficult times, will start hoarding money too, making things even worse for me. So there's a vicious circle at work here: people hoard money in difficult times, but times become more difficult when people hoard money. 

The cure for this, Keynes said, was for the central bank to expand the money supply. By putting more bills in people's hands, consumer confidence would return, people would spend, and the circular flow of money would be reestablished. Just that simple! Too simple, in fact, for the policy-makers of that time.
If this is the proposed definition and cure for recessions, then what about depressions? Keynes believed that depressions were recessions that had fallen into a "liquidity trap." A liquidity trap is when people hoard money and refuse to spend no matter how much the government tries to expand the money supply. In these dire circumstances, Keynes believed that the government should do what individuals were not, namely, spend. In his memorable phrase, Keynes called this "priming the pump" of the economy, a final government effort to reestablish the circular flow of money. 

Let's return now to the reasons why people start hoarding money in the first place. There are many possible explanations, all of which are open to argument. It may be a consumer loss of confidence in the economy, perhaps triggered by a visible event like a stock market crash. It may be a natural disaster, such as a drought, earthquake or hurricane. It may be a sudden loss of jobs, or a weak sector of the economy. It may be inequality of wealth, which results in the rich producing a surplus of goods, but leaving the poor too poor to buy them. It may be something intrinsic within the economy which causes it to go through a natural cycle of recessions and recoveries. Or the Federal Reserve may tighten the money supply too much, compelling people to hang on to their disappearing dollars. This last point is especially important, since many critics of activist government believe that is how the Great Depression started. 

As mentioned above, Keynes' advice on ending the Great Depression was rejected. President Roosevelt tried countless other approaches, all of which failed. Almost all economists agree that World War II cured the Great Depression; Keynesians believe this was so because the U.S. finally began massive public spending on defense. This is a large part of the reason why "wars are good for the economy." Although no one knows the full secret to economic growth (the world's top economists are still working on this mystery), wars are an economic boon in part because governments always resort to Keynesian spending during them. Of course, such spending need not be directed only towards war -- social programs are much more preferable. If it sound as if I am a Keynesian please continue to read. I am not. I happen to believe in the free markets but wait there's more to tell, One of the first major critics was Milton Friedman. Although he accepted Keynes' definition of recessions, he rejected the cure. Government should butt out of the business of expanding or contracting the money supply, he argued. It should keep the money supply steady, expanding it slightly each year only to allow for the growth of the economy and a few other basic factors. Inflation, unemployment and output would adjust themselves according to market demands. This policy he named monetarism.
Friedman is also famous for a second theory, this one containing more merit. It's called the natural rate of unemployment, and it goes something like this: 

Imagine an economy where the cost of everything doubles. You have to pay twice as much for your groceries, but you don't mind, because your paycheck is also twice as large. Economists call this theneutrality of money. If inflation worked this way, then it would be harmless. Indeed, most presidents after World War II decided to accept high inflation if it meant low unemployment, and therefore urged the Federal Reserve to conduct an expansionary monetary policy. But why is it that when the Fed expands money by, say, 5 percent, that all prices and wages everywhere do not go up by 5 percent as well? Why is it that the neutrality of money does not make this expansion meaningless? Friedman argued that it was because the public was unaware of the expansion, or what it meant, or by how much if it did. In other words, they didn't know that they should raise their prices by 5 percent. When the extra money was pumped into the economy, therefore, it was unwittingly translated into more economic activity, not higher prices. 

Of course, if businessmen knew that a 5 percent increase was coming, it would be in their best interest to just raise their prices 5 percent. That way, they would make the same increased profits without having to work for them. If everyone did this, then the Fed's monetary increases would become meaningless -- instead of resulting in more jobs, it would just create higher inflation. Friedman and others argued that as businessmen became savvier and learned to follow the Fed's actions, they would build their inflationary expectations into their prices. Not only would this make inflation worse, but the nation would be left with no tool to fight unemployment, which would eventually rise as well. The twin dragons of inflation and unemployment would therefore grow together, forming "stagflation." 

Friedman showed that monetary policy could not be used to wipe out unemployment, one of the optimistic goals of the Keynesians shortly after World War II. Instead, the most monetary policy could do was keep unemployment at about 6 percent, which is the rate normally achieved when the inflation rate is what the market expects it to be. Friedman called this the "natural rate of unemployment," and it secured his fame. But Keynesian policies are still useful in keeping the unemployment rate as close to 6 percent as possible.

NY TIMES writer, Paul Krugman says that almost $900 billion in stimulus didn’t work because it wasn’t big enough, you have to wonder if an adequate Keynesian stimulus is even possible.  Could any government anywhere borrow 15% of GDP or more to spend on temporary measures with the blessing of their citizens?  For that matter, would the markets lend the money without ratcheting up interest rates?  Can an extra 15% of GDP be spent without showing sharply diminishing returns; meaning that you’d need even more spending to generate the effects you want?
Today Alex Tabarrok looks at the history and concludes that even if Keynesian economics works in theory, Keynesian politics fails in practice at least in a Republic such as ours run as a democracy.
I conclude with this:
If in the past these economic stimulus projects worked it was in part because the public was unaware of the puppet masters pulling the strings. They public and the markets behaved according to plan, but today with the media awareness and information super highway driving the economy as fast as it can there is no ability for the Fed to manipulate thoughts and behaviors and the public is running for the hills. That coupled with the fact that 40 cents of every dollar spent by the US Government is borrowed from China; makes it an impossible situation for our Keynesian President Obama to survive.
sources for this article were found here  and at