Blumen is right about Epstein’s good column in Barron’s. Here is most of it:
Think back to The Godfather — the book, not the movie. It describes a Mafia chief who owns a firm that does highway repair in the New York City area. But the gangster also owns a fleet of freight-hauling trucks that ruin the highways with their heavy overload (his political connections ensure that they won’t get stopped).
As author Mario Puzo observes, this is an ingenious operation — “business of itself creating more business.”
The Monetary Man and his fiscal brother pursue the same racket. They fix what they themselves have already helped ruin, except in this case, what they ruin is the economy — and that creates the business of fixing things up.
Here’s what happens. Through what the textbooks call open-market operations, the Federal Reserve pumps excess money and credit into the economy — an “excess” in the sense that the funds out on loan are way out of proportion with the amount available from the funds the economy has actually saved.
In past years, the Fed blew up the supply of credit in a proactive way. Today, it does this reactively, satisfying all demand for loans, of which it has an infinite supply. What it does proactively is set the price of credit by targeting the overnight interest rate on federal funds.
Now, there are times when its fiscal compatriot demands that money be printed to finance it own operations. The federal government then spends the money it got from the central bank’s bottomless pit, thereby becoming the conduit through which the money pours into the private economy.
This sort of thing began in the mid-’Sixties and persisted through the ‘Seventies, a time when fiscal policy essentially drove monetary policy, with disastrous results.
Either Monetary Man or Fiscal Man can cause plenty of damage on his own. Just think about what happened in the years leading up to the crash and recession from 2000 to ‘01. The central bank allowed a staggering amount of excess credit to flow into the economy, which spilled over into the stock market, triggering a fantastic speculative boom, mainly in tech stocks traded on Nasdaq. A market bust and recession were almost inevitable.
Of course, there are knee-jerk Keynesians who blame every recession on a “failure of demand.” They’ll have trouble explaining how it could be that real consumer spending rose throughout this period.
Nobel laureate economist Robert Solow recently attributed declines in GDP to the problems faced by “producers and sellers [who] cannot find enough willing buyers at the prices they are charging.” I mentioned Solow’s line of thinking last week, but I didn’t explain its shortcomings very clearly. Now I will: The latest recession makes a parody of the Solow view, since so many of the “producers” who went bust did so before they could even market their product, much less sell it.
Solow insists that his “producers and sellers” who are charging too much should on no account charge less. But in this situation, lower prices are the only way the market can get GDP off the dime. By declaring it out of bounds, Solow leaves us with only one alternative: government intervention — fiscal or monetary or both.
Now, most folks think of monetary and fiscal policy, and the institutions involved, the way they think of Mount Rushmore. You don’t blame Rushmore if you fall off it. Similarly, there is room for debate over whether Fed chairman Greenspan could have done things differently, a sport that will probably never end. But you don’t say Rushmore must be abolished.
I’m saying the Fed should be abolished. Fiscal policy is a more complicated animal, but it too must go.
