Some Basic Economics of Public Policy

Government can raise revenue in one of three ways: (1) tax, (2) borrow and (3) inflate.  The natural proclivity of democratic governments is to pursue public policies which concentrate benefits on the well-organized and well-informed, and disperse the costs on the unorganized and ill-informed.  And there are strong reasons why this bias in policy making will also be biased toward shortsightedness --- pay out the benefits now, and worry about the costs down the road.  Thus, the natural tendency for elected government officials is to borrow (rather than tax) and then inflate (rather than tax).  Deficit financing, accumulating public debt, and monetization of the debt.

Now a lot of individuals have been claiming that economics as a scientific discipline has been rocked by our current crisis, both due to our failure to "predict" it and our inability to "fix" it with a consensus on the right public policy.  And anyone not deeply read in the history of our discipline, or who received their university education in economics in the second half of the 20th century can be excused for such a reading of the situation.  This would be the most logical interpretation one could arrive at --- especially if you not only listen to President Obama say that we must work past the dead ideologies of the past and the "do nothing" arguments (as if that argument has been actively pursued since Grover Cleveland).

But what if the problems are not the dead ideologies, but instead a live political pragmaticism that has forgotten the basic ideology that made possible the great growth of the wealth of nations and provides the foundation for Western civilization?  Namely, private property (as Hume put it: a system of property, contract and consent), freedom of trade, and social cooperation under an international division of labor.  Government rather than unleashed must be constrained; and constrained in such a binding way that it is not possible for elected officials to pursue the natural proclivities to provide privileges to political favorites (concentrating benefits and dispersing costs).

Adam Smith warned with respect to not only free trade, but also public debt that what was folly for the individual is certainly folly for the nation.  Well just look at some basic economic data --- budget deficits or surpluses as a percentage of GDP from the Congressional Budget office. We have had pretty big deficits since 9/11.

Milton Friedman taught us that inflation is everywhere and always a monetary phenomena.  Wage-pull, or cost-push inflation stories do not make sense.  The oil shocks of the 1970s don't explain inflation, it would explain a relative price change, but not a change in the general price level.  Money supply and money demand determine that.

However, as Tom Sargent has discovered in his work on hyper-inflation, Friedman's dictum is correct, but could be modified by simply pointing out that hyper-inflations are everywhere and always preceeded by fiscal imbalance.  In short, the natural proclivity of government has consequences.  They want to spend more to meet electoral promises, they do so in the short run, and when the bill comes due they want to print more money to pay back in cheaper currency.  When spending gets really out of control (is a national debt of $10trillion out of control?!), then they monetize at such a rate to threaten to destroy the currency through hyper-inflation.  A broad definition of the money supply is MZM and it is kept by the St. Louis Fed -- as you can see it has been going up.

The US has made a lot of bad policy choices that violate the teachings of basic economics and common-sense for over half a century.  We have not yet destroyed the US economy through these choices, but we are potentially on that path. The most effective way to get off that path would be to establish new restraints on the natural proclivities of elected politicians (take away discretionary powers in fiscal and monetary policy) and unleash the private sector and the creative powers of entrepreneurs. We can still pull out of this current crisis, but first government must stop making matters worse by catering to the natural proclivities of elected officials (from whatever party).  As James Buchanan once summed up the policy wisdom of public choice: "Don't let the fox guard the chicken coup."

Bottom line: combine Buchanan's warning about the guardians, and Hayek's insight on the creative powers of a free civilization, and you have your answer.  It ain't rocket science, it is just economic science.

Comments

[William Luther]

Dr. Boettke,

I have found the following three articles by Sargent on hyperinflation:

"Rational Expectations and the Dynamics of Hyperinflation"
Thomas J. Sargent, Neil Wallace
International Economic Review, Vol. 14, No. 2 (Jun., 1973), pp. 328-350

"The Demand for Money During Hyperinflation under Rational Expectations: II"
Michael K. Salemi, Thomas J. Sargent
International Economic Review, Vol. 20, No. 3 (Oct., 1979), pp. 741-758

"The Demand for Money during Hyperinflations under Rational Expectations: I"
Thomas J. Sargent
International Economic Review, Vol. 18, No. 1 (Feb., 1977), pp. 59-82

Are there any others you would recommend with respect to the idea that "hyper-inflations are everywhere and always preceeded by fiscal imbalance."

Thanks.

[Dave Prychitko]

Pete's recent posts remind me of the final few chapters in Mises's Human Action.

Keep goin', Pete. Keep goin'

[Sheldon Richman]

Bravo! Timely and well put!

[RickC]

Dr. Boettke,

One of my absolute favorite posts. Which is saying something for this blog.

Over the last few days I've been thinking about this downturn as the world-wide phenomenon that it's become. One begins to wonder why now, and what could be the possible underlying cause/s for similar events under differing types of regimes; some more statist and some more free market.

My own suspicion is that it was easy credit growing out of government action and the monetary policies of central banks. It's led me to think that the discussion of rationality/ irrationality should be directed more at the system under which people function rather than at individual actors. After all, when the system encourages people to pursue morally and fiscally hazardous behavior why is it surprising that they do.

That's why the whole discussion on greed and/or inadequate regulations/transparency being the root cause of the problems here in the U.S. seem ultimately problematic for me. They don't answer the question of why world-wide?

Does anyone have any thoughts on why the current difficulties are so widespread?

[Gary M Caldwell]

I personally have lived most my life in the desert of the SW us and hearing these different politics makes me thank the earth is playing high and low tides at the sun itself. I think it only natural of mankind to try to solve this problem but economics is putting the majority of people on the edge in that it is good if we just understand that the love of money is the root of all evil and that we should have let nature take its course in the car indaustrys and such and also I believe the was is finally backlashed to test our strength to see if we had enough for the war. A good leadeer always checks first to see if he can afford a war is why I say the natural course would have been maybe two years of hard time them the slump would have started anew woth work and its own stimulus. Now the people are going to want money thank about it god bless

[Brian Wright]

Hello,

I'd like to have access to a copy of Some Basic Economics of Public Policy in a black on white format. The short article by Boettke is beautiful but the format is unusable and unreferenceable, IMHO.

Brian Wright
http://www.thecoffeecoaster.com/
[email protected]