Lecture 16 Economic Stability and Growth

8/13/2019 Lecture 16 Economic Stability and Growth

1/36

A Libertarian Perspective on

Economic and Social Policy

Lecture 16

Economic Stability and Growth2009 Jeffrey A. Miron


2/36

Introduction

Traditional libertarianism is most often associated withmicroeconomic issues, and the standard libertarianinsights might seem better suited for addressing thosekinds of policies.

Macroeconomic policies are important too, however; These policies affect the entire economy, so the potential for

benefits or costs are greater than for many micro policies.

And, bad economic times often give rise to bad economicpolicies generally.

So, even libertarians might consider intervention to improve the

overall functioning of the economy if this intervention works andpromotes better policies in other areas.

This lecture examines a range of macroeconomicpolicies from a libertarian perspective.


3/36

Introduction, continued

Despite the fact that issues of rights,

externalities, and the like are less obviously

relevant for macroeconomic issues, I will

suggest that the version of libertarianism I havepresented in this course thoughtful cost-benefit

analysis is just as useful for examining macro

policies as it is for examining micro policies:

And this approach leads to similar conclusions:

Most interventions do more harm than good.


4/36

Outline

Stabilization Policy

Deficits

Central Banks and Money

Fixed Versus Floating Exchange Rates The Exchange Rate as a Target

The Balance of Trade

Free Trade Immigration

Foreign Aid


5/36

Stabilization Policy

Until the Great Depression of the 1930s, thefocus of most economics was micro: The idea that the overall economy could suffer a

general, coordinated decline was not given much

attention.

Instead, analysis addressed the behavior and failuresof individual markets, assuming that with a largenumber of individual markets, some growing and

others declining, overall economic progress would bereasonably steady, and any fluctuations would reflectexogenous, unavoidable events such as weather ordisease (e.g., the bubonic plague).


6/36

Stabilization Policy, continued

The Great Depression changed this view:

Many economists concluded that capitalist economies

could suffer substantial, prolonged downturns from

which they would not quickly recover on their own. Macroeconomists therefore developed two

things:

A theory of cycles and recessions (based on sticky

prices); A theory of how policy could reduce or eliminate

these cycles, i.e., stabilize the economy.


7/36


8/36

Problems with Stabilization Policy:

The Lags are Long and Variable

A basic problem with stabilization policy is

that it affects the economy with a lag:

This is partly because it takes time to

recognize that the economy is going into a

recession;

This is partly because it takes time to choose

and implement an appropriate policy; This is party because it takes time for the

chosen policy to affect the economy.


9/36

Long and Variable Lags,

continued The lags would not be an issue if forecasting were easy

and if the lags were of fixed or highly predictable length: Under these assumptions, policymakers can simply start

adjusting policy in anticipation of an expected downturn, therebysmoothing out the cycle.

In practice, however, forecasting is an inexact science,and the lags in policy are long and variable.

Thus, attempts at stabilization can easily be counter-productive, i.e., destabilize the economy.

The evidence on whether policy has stabilized or destabilizeddoes not make a compelling case in either direction.

But it certainly fails to indicate that policy has on average been astabilizing force.


10/36

Aside: What did We Learn from the

Great Depression? The Great Depression was regarded at the time as proof

that economies are inherently unstable and thatstabilization policy is needed.

In fact, later research (Friedman and SchwartzsAMonetary History of the United States) argues that amodest recession became the Great Depressionbecause the Fed allowed the money stock to fallsubstantially: Thus, F&S claim the Great Depression resultedfrom bad policy,

rather than being evidence that active policy is desirable.

There is a range of opinion among reputable economistsabout the FS hypothesis. But few deny the possibility that policy contributed substantially

to the outcome.


11/36

Long and Variables Lags,

continued A possible response to the long and variable lags is that

policy should attempt to stabilize, but cautiously: That is, only take action in response to large, obvious shocks,

rather than attempting to fine-tune.

In fact, there is no longer much support for fine-tuning, despite

continued support for some degree of activism. A second possible response is that, over time, the

uncertainty about policy and the difficulties in forecastingwill diminish; Plus, there will be learning by doing, so its useful to practice.

These arguments are not totally silly, and if there wereno other costs to stabilization policy, they might bepersuasive.

But there are substantial other costs.


12/36


13/36


Growth versus Stabilization

A related problem with the focus on

stabilization policy is that it distracts from

thinking about growth:

There is a reasonable case that the benefits

of even slightly faster growth swamp any

benefits of reduced fluctuations.

The stabilization view therefore encouragesthinking about the less important issue.


14/36

Problems with Stabilization:

Adding Uncertainty

A different effect of stabilization policy is thatthe private sector expends resources forecastingwhat policy is going to do, instead of justforecasting what the economy is going to do.

This is wasted effort; the extra uncertaintycomplicates life for the private sector.

Indeed, there is a plausible case that some

instability arises from the private sector trying tofigure out what policy is going to do, rather thanfrom inherent instability.


15/36


Microeconomic Considerations One standard tool of stabilization policy is increased or

decreased deficits: Cutting taxes or raising expenditure expands the economy, and

vice versa, so policy can attempt to offset fluctuations byadjusting taxes or expenditure.

The problem is that taxes and expenditure havemicroeconomic implications, independent of any impactson stabilization. That is, Deficit = G T

And we should care about the levels and composition ofG and T separately, not just the difference.

It is possible that policy should consider both effects: But it certainly should not ignore the micro side.


16/36

Deficits and Debt

The conventional view of budget deficits and governmentdebt is that these are bad things:

In particular, the standard claim is that when thegovernment runs a deficit it must borrow from the

public, which raises interest rates and crowds outprivate investment.

This view is reasonable, but it is not the only possiblescenario:

Under Ricardian equivalence, deficits have no effect.

Existing evidence suggests the U.S. economy is some-where between the extreme views.


17/36

Deficits, continued

How should libertarians feel about deficits?

The first reaction should that expenditure is toohigh in most economies and should be reduced,independent of the deficit.

If this occurs, deficit issues become moot. A second reaction might be that, even if

expenditure is not cut right away, starving thebeast helps control expenditure over time:

Thus, (virtually) all tax cuts are a good thing, even ifthey raise the deficit.

In fact, the evidence does not support STB.


18/36

Central Banks

If stabilization policy is undesirable, is there agood reason for a central bank?

No. Once a central bank exists, it will intervene.

The only intervention that is necessary in connectionwith money (i.e., the means of payment) is thatgovernment must establish what form of payment itaccepts in those transactions it conducts.

This may establish a default money.

But everything else can be done privately.

Note that the U.S. got along quite well without acentral bank until 1914.


19/36

Fixed Versus Floating

Exchange Rates

A different macroeconomic question that

economies confront is whether to have a

fixed or floating exchange rate.

Eliminating the central bank does not

avoid this issue, since Treasuries can and

do attempt to peg exchange rates.

And its an important question for countries

that do have central banks.


20/36

Fixed Versus Floating

Exchange Rates, continued

This is an easy issue: There is no sensible case for fixed rates.

The negative things people associate with

exchange rates (e.g., currency crises) can onlyhappen under fixed rates: Under floating, the rate simply adjusts to changes in

the demand and supply, just like for any other good.

Moreover, much of the uncertainty aboutdemand and supply occurs because offluctuations in government policy towardexchange rates and related issues.


21/36


22/36

The Current Account Deficit

In addition to worrying about the exchange rate,

countries worry about current account deficits.

The balance of trade of any country is the record

of all its transactions with the rest of the world. This balance of trade has two pieces:

The current account, which records trade in goods

and services. It equals exports minus imports and is

often referred to as net exports.

The capital account, which records trade in assets.


23/36

The Current Account Deficit,

continued

An inescapable fact of accounting is that thebalance of payments always balances: CA + KA = 0.

In words, if I buy a bottle of wine from France, theU.S. has a CA deficit but an offsetting KA surplus:

Goods flowed into the U.S. but an asset (the dollars Ispent on the wine) flowed out.

NB: if I first bought francs from France, that was a

wash in the KA. The CA and KA do not necessarily balance

individually and in fact are zero only rarely.


24/36

The Current Account Deficit,

continued The question is, should a country care whether its CA is

positive or negative?

If the CA is negative, it means the country is borrowingfrom the rest of the world.

There is nothing inherently bad about that. A CA deficit might be a reflection of underlying problems:

A CA deficit occurs when domestic saving is low.

So, if there are policies that inappropriately discouragesavings, it makes perfect sense to undo those. But this would be true in a closed economy.

The CA deficit plays no independent role.


25/36

Free Trade

Of all the propositions in economics, the view that freetrade is best is perhaps the most widely held. And forgood reason: Barriers to trade such as tariffs or quotas reduce or prevent

Pareto-improving exchange;

And trade has additional benefits, such as providing competitionfor domestic industry.

Are there reasonable arguments for restrictions? In theory, perhaps, but in practice, no.

This does not mean trade is always good for everyone: It adversely impacts low-skill labor in high-wage countries.

But it also helps low income workers through standard channels,and it makes more sense to redistribute directly, if warranted.


26/36

Free Trade, continued

The libertarian view, therefore, is that any

country with trade barriers should remove them,

unilaterally and immediately.

The one possible argument against thisapproach is that, by threatening to retain its

trade barriers, a country like the U.S. might

convince other countries to reduce theirs.

This is possible in principle:

In practice, it simply seems to be an excuse for further

delay in removing existing barriers.


27/36

Immigration Restrictions

Until the end of the 19th century, the U.S.had virtually no regulation of immigration.

During the early 20th century, there was

some regulation and a few notoriousrestrictions enacted (in particular, theChinese Exclusion Act of 1882).

But overall, immigration was barelyregulated by todays standards, andimmigration rates were high.


28/36


29/36

Immigration

Most (rich) economies restrict immigration

substantially.

There is no good efficiency argument for this; in

fact, restrictions reduce global efficiency. The only argument is distributional:

Existing low-wage workers are likely to lose out as a

result of immigration, which fits with the fact that

unions and other low-wage groups strongly opposerelaxed immigrations restrictions.


30/36

Immigration, continued

The libertarian position is that income effects are bestaddressed, if at all, using other policies such as an NIT.

Thus, libertarians tend to favor eliminating all barriers toimmigration.

The only possible caveat is that one significant group ofbeneficiaries the immigrants are not (yet) citizens orresidents of the country allowing the immigration. So, some would argue they deserve less weight in the social

welfare calculation.

If there were no costs of immigration restrictions, thismight be a tough issue.

But there are such costs.


31/36

Costs of Immigration Restrictions

Like all prohibitions, those on immigration

generate black markets, with all the standard

negative effects:

Violent dispute resolution Disrespect for the law

Rewarding the relatively dishonest

Corruption

Reduced product quality

Plus, there are direct costs of enforcement.


32/36

Immigration and Security

A different argument for restricting immigration is

that this is necessary to keep out terrorists.

But the restrictions do not work particularly well:

Tons and tons of illegal drugs enter every year Hundreds of thousands of illegal immigrants enter

every year

It is hard to see how a determined terrorist is

affected by any enforcement regime we canimagine.


33/36

Foreign Aid and Lending

In addition to trying to manage their own

economies, some countries (the rich ones)

attempt to manage developing economies.

The main mechanism is organizations like

the IMF and the World Bank, which lend to

poor countries conditional on adoption of

the right economic policies.


34/36

Foreign Aid and Lending, continued

This policy sounds sensible in theory; thepractice is much tougher.

First, stabilization policy is difficult at best, asdiscussed above.

Second, ensuring that the recipient countriesfollow these policies is hard.

Third, there is much scope for diversion of the

funds to bad purposes. Fourth, the incentives of the IMF, WB are to

keep making loans, not to be tough.


35/36


36/36

Conclusions

Eschew active stabilization policy.

Choose spending levels and tax programsbased on efficiency considerations.

Eliminate the Fed; fix the money stock atwhatever it is now (or adopt a rule).

Let the exchange rate float.

Ignore the exchange rate and the CA deficit in

making policy. Free trade, unrestricted immigration.

Leave other countries alone.

Lecture 16 Economic Stability and Growth

Documents

Transcript of Lecture 16 Economic Stability and Growth