50, NO. 1, JANUARY 2000
The Government is the Stabilizer?--It
Just Ain't So!
Stability is the perennial issue in macroeconomics.
The economist's judgment about the stability of the market economy stems
from what Joseph Shumpeter called the "pre-analytic vision." To illustrate
the point, Schumpeter specifically used John Maynard Keynes and his pre-analytic
vision: Markets are inherently unstable; the government is the stabilizer.
This belief, or vision, was held by Keynes years before he published his
General Theory in1936.
The most fundamental criticism of Keynesian economics has been offered
by those who embrace the opposite vision: Markets are inherently stable;
the government is the destabilizer. This is the view of Ludwig von Mises
and F. A. Hayek. The evidence of more than a half-century of failed "stabilization
policy" strongly supports the Mises-Hayek view. The Keynesians can persist
only by arguing that particular countercyclical measures were too weak
or implemented too late. Underlying the whole debate, however, is a fundamental
and enduring Conflict of Visions-to use the title concept of Thomas Sowell's
Writing for the New York Times (8/22/99 Week in Review, p. 5) Louis Uchitelle
asks, "Who You Gonna Call After the Next Bust?" His answer-and those of
the authorities on whom he relies-are Keynesian answers in the most fundamental
sense. Note the vision-bound assessment of Robert Pollin (University of
Massachusetts): "[Markets] can't cure themselves. We will have to acknowledge
that we need government for that. It's the stabilizer." And note that Princeton's
Alan Blinder imputes the Keynesian vision to the public: "In the event
of a recession, people turn to Government en masse."
Though there is dispute at the most fundamental level, there can be agreement
about the likely course of the economy in the months or years ahead. According
to Uchitelle, "the eight-year expansion walks on precarious legs, and when
it collapses, getting the American economy back on its feet could be surprisingly
hard and painful." No doubt. But why, specifically, do we say the legs
are precarious? And who, exactly, is supposed to be surprised that recovery
will be hard and painful?
Uchitelle writes that "The strengths of this expansion are potentially
destructive." [Read: Strengths are weaknesses; the market is inherently
unstable.] He sees precariousness in the fact that "the current expansion
is fueled by private-sector debt." Fueled? The Keynesian notion that the
government can "fuel" the economy ["'goose' the economy" would be more
apt] by deliberately spending more than its tax revenues has been uncritically
transplanted to the private sector: "It is deficit spending that stimulates
an economy, whether it comes from the private or public sectors." Particularly
troublesome, according to Uchitelle, is the prospect that the private-sector
stimulant will turn into a public-sector handicap when the bubble bursts.
The government will then have to resort to deficit finance to stimulate
a already debt-wracked private sector. It is as if the government "were
starting a one-mile race from 100 yards behind the starting line."
Economists who understand the market's self-stabilizing properties find
no special significance in private-sector debt. It doesn't fuel, it doesn't
stimulate; it doesn't signify precariousness. Private-sector debt is simply
the sum total of the indebtedness of many business firms and individual
entrepreneurs. Most have borrowed on the basis of sound judgment and a
healthy grasp of their particular economic circumstances. The profits they
earn will put them in command of even more resources in the months and
years ahead. Some, though, have borrowed on the basis of faulty judgment.
They will incur losses and will find themselves in command of fewer resources.
This is the nature of the market process; this is the system of profit
Exonerating private-sector debt per se does not mean that this debt is
never a symptom of a problem. But what is the underlying problem? What
accounts for the increased level of indebtedness noted by Uchitelle? Is
it a credit expansion engineered by the central bank? Is it banking legislation
that has encouraged financial institutions to take undue risks while the
FDIC continues to provide deposit insurance at subsidized rates? Is it
the too-big-to-fail doctrine that has guided regulators in dealing with
overextended financial institutions?
It is, of course, all of the above. Centrally orchestrated credit expansion
is the cause of boom and bust as spelled out by Mises and Hayek. Externalizing
risks and subsidizing risk-taking behavior is another way of fostering
an unsustainable boom. And the standard classical case for the system of
profit and loss does not fully apply to a system of profit and too-big-to-fail.
To recognize these aspects of our mixed economy is to understand that it
is because of government policy that the private sector "walks on precarious
Though not noted by Uchitelle, a clear indicator of "precariousness" is
the market's perverse reaction to seemingly good economic news. In recent
times, when the unemployment rate goes down, speculators turn bearish.
Why so? Isn't lower unemployment a good thing? One view has it that the
current unemployment rate (about 4.2 percent) is unsustainable-because
it is significantly below the so-called natural rate of unemployment (generally
believed to be 5.0 to 6.0 percent). The alternative view is that the natural
rate itself has fallen. In an unregulated market economy, the question
of which of these two views is correct would be an idle one. But if a central
bank is in charge of stabilizing the economy, the question takes on critical
significance. Which view does the central bank think is correct? And what
policy implications are implied? With each movement of the unemployment
rate, speculators reform their expectations about what the Fed is likely
to do and when it is likely to do it. A central bank trying to manipulate
the market while the market tries to anticipate and hedge against the central
bank's actions is not a recipe for macroeconomic stability.
So, who you gonna call after the next bust? If government is the destabilizer,
it makes little sense to turn to that same government for stabilization.
But the Keynesian economists are sure to make that very call, and the government
is sure to respond. Recovery will be hard and painful. Who, though, will
be surprised? Not the students of Mises and Hayek.
According to Pollin, acknowledging that we need government to provide stability
"will open up a broader debate about what government should do." Uchitelle
has some ideas of his own here. The Federal Reserve, he argues, has had
primary responsibility for stabilizing the economy over the past twenty
years. It lowers interest rates when the economy begins to falter and encourages
the private sector to take on more debt. Now, with private-sector debt
at worrisome levels, we need to shift the emphasis from monetary policy
to fiscal policy. Uchitelle sees room for old-line Keynesian spending programs:
"More government spending on housing, public works, education and income
subsidies seems likely to accompany the next recession...."
Students of Mises and Hayek would opt for decentralizing the monetary system
rather than calling on the central fiscal authority to aid and abet the
central monetary authority. But no. Suddenly, it's 1936 again. Keynesianism
is back-and in its rawest form. Many people "shun the label" (Blinder notes),
and we may need to "change the rhetoric" (Pollin suggests). But as we prepare
to do battle against the next recession, we can take comfort-or so we're
led to believe--in Richard Nixon's celebrated proclamation that "We're
all, er, ah, Uchitellians now!"
Roger W. Garrison