Monday, February 23, 2009

The “Instrument Instability” Phenomenon and the Current Economy

Jeffrey Sachs sees a much larger role for government overall in the economy than I do, so I can't agree with his views against tax cuts. I can't support his Keynesian beliefs. And, I can't support his Chicago School monetarist policy prescriptions. Indeed, how he fits all these contradictory policy prescriptions so that he can hug them all at the same time is a bit hard to figure.

That said, out of this mish mash, he has written for Scientific American some absolute pearls of wisdom that I wish I had written:

1.The U.S. political-economic system gives evidence of a phenomenon known as “instrument instability.” Policy makers at the Federal Reserve and the White House are attempting to use highly imperfect monetary and fiscal policies to stabilize the national economy. The result, however, has been ever-more desperate swings in economic policies in the attempt to prevent recessions that cannot be fully eliminated.

2.Looking back to the late 1990s, there is little doubt that unduly large swings in macroeconomic policies have been a major contributor to our current crisis. The lessons of the high inflation of the 1970s had supposedly chastened policy makers against trying to fine-tune the economy. The quest for never-ending full employment had contributed to high inflation in that decade, which required years of economic pain to wring out of the system. Monetary policies thereafter were supposed to be “steady as she goes,” not trying to smooth out every fluctuation and business cycle in the economy.

3.Most important, we should stop panicking. One of the reasons we got into this mess was the Fed’s exaggerated fear in 2002 and 2003 that the U.S. was following Japan into a decade of stagnation caused by deflation (falling prices). To avoid a deflation the Fed created a bubble. Now the bubble has burst, and we’ve ended up with the deflation we feared! Panics end badly, even panics of policy; more moderate policies will be safer in the medium term.

There is little reason to fear a decade of stagnation, much less a depression. The U.S. economy is technologically dynamic and highly flexible.

1 comment:

  1. And now:
    1. Print more money
    2. Act clueless (to get stock prices down for major banks)
    3. Nationalize banks
    4. Lend money to everyone
    5. Burn off excess to curb inflation
    6. And in 2 to 4 years your cake is done.