There is an argument going on which has real life consequence for all of us. This subject has taken on an urgency because of what is going on in the economy right now, but in reality, it is a fairly old debate. The questions are:
1. What caused the current financial and economic crisis?
2. How does the current crisis compare to the Great Depression?
and most importantly,
3. What should the government do?
There is an infinity of answers, but I am going to categorize them into two broad, somewhat oversimplified camps: the Keynesian interventionists and the Austrian-school libertarians. For the interventionists, I will pick Professor Paul Krugman as the standard bearer. For the libertarian camp, I will pick Congressman Ron Paul. Though both have their political affiliations, neither of them have been close to positions of power, so you cannot accuse either of them of actually causing anything, unlike other partisans to the debate. I am going to state their arguments as clearly as possible, but be aware of my own libertarian bias.
1. What caused the present crisis?
The interventionist crowd argues that it is a failure of the market, which itself was caused by the failure of government to adequately regulate the financial industry. Many years of ideologically driven hands-off Federal Reserve as well as government policy led to a relaxing of regulatory standards and oversight. This led to excessive risk taking, which led to the crisis.
The libertarian crowd argues that it was the Federal Reserve that primarily caused the crisis, with its faulty monetary policy. The Fed's asymmetrical policy led to a series of asset bubbles, and as each bubble burst, monetary policy became ever easier, leading to excessive risk taking with borrowed money. There was an implicit assumption among speculators that the Fed would come to the rescue, so really bad things cannot happen. Overall debt in the economy, expressed as a proportion of GDP, increased to historic levels.
One complication in this is Alan Greenspan, the Chairman of the Fed during the entire time, used to consider himself a libertarian, but people like Ron Paul had been warning him of his reckless monetary policy all the while, so from a libertarian point of view, Greenspan was only libertarian-in-name.
More recently, Greenspan seems to have conceded that more government regulatory oversight may have been needed, placing himself belatedly and partially in the interventionist camp on what caused the crisis.
2. How does the current crisis compare to the Great Depression?
Both camps would agree that the present crisis has disturbing parallels to the Great Depression, but the agreement would stop there. They fundamentally disagree on what prolonged the Great Depression, and finally how the economy got out of it.
Interventionists argue that it was the Fed's deflationary money policy that led to the Great Depression, therefore the foremost responsibility of the Fed today is to keep monetary policy easy, to prevent deflation. Interventionists also argue that it was the New Deal economic policies that by and large pulled the economy out of the depression. In fact, interventionism itself became the dominant school of thought with the New Deal.
The libertarians argue that deflation was an inevitable consequence of a badly distorted economy created by an artificial credit boom, adjusting itself back. In particular, bad investments made during the credit boom had to be written off, asset values had to find their true level, and that was the only way to cure the economy. Left to itself, the economy would have had a short, deep recession, and as price levels adjusted, economic activity would have started to climb back. In the libertarian view, government intervention actually prolonged the depression.
3. What should the government do now?
We already know the answer to this one: we are going to have a series of government interventions, each bolder than the previous one. By far the dominant school of thought today is the Keynesian inverventionist camp. Contrary to partisan political rhetoric, the difference between the two political camps is fairly mild, and deals with really how much intervention is too much.
Libertarians are but a fringe and are mostly considered relics. I happen to belong to that fringe, which is why you even read about them in this blog! As Professor Krugman advises President-elect Obama (emphasis in the original):
Implications for Obama: be inspired by FDR, but don’t imitate him slavishly. In particular, your economic policy should be bolder, not more cautious.
As I said in the beginning, this is going to be of momentous consequence. If the libertarians are right, we are in for really, really tough times, and bold interventions of the kind Krugman advocates are only going to prolong the misery. In any event, we are going to be subject to a real world experiment. Let's wish ourselves luck.
So what would constitute success in this experiment? Let's set some simple goals: a) unemployment should decline in 4 years, so let's say that if unemployment in 2012 is less than 6%, interventionists have succeeded b) inflation should be reasonably contained - let's say under 4%.
Update: I would add a debt covenant, so that US government debt, as a percentage of GDP, should not exceed 100% - it somewhere in the 80% zone now. Japan's various interventions over 18 years have resulted in doubling their public debt - now at 160% of GDP. Japan still hasn't fully recovered from its own bubble burst in 1990, which should give pause to the interventionists.
I would be happy to acknowledge the interventionists' success, of course.
Ian,You are certainly not the first to call on everyone to avoid belief systems and ideology, focus on bipartisanship, post-partisanship, etc. We hear this all the time from mainstream publications. I find these calls to be well-intentioned but hopelessly misguided. The irony is that you appear to have a belief system of your own: a very strong belief in the status quo, particularly when it comes to the education system. You don’t seem to notice it, however - probably because the vast majority of people agree with you.I apologize if this comes off as a bit harsh and personal. Again, a main point of mine is that it’s not just you that holds these beliefs.
Ian,You are certainly not the first to call on everyone to avoid belief systems and ideology, focus on bipartisanship, post-partisanship, etc. We hear this all the time from mainstream publications. I find these calls to be well-intentioned but hopelessly misguided. The irony is that you appear to have a belief system of your own: a very strong belief in the status quo, particularly when it comes to the education system. You don’t seem to notice it, however - probably because the vast majority of people agree with you.I apologize if this comes off as a bit harsh and personal. Again, a main point of mine is that it’s not just you that holds these beliefs.
Ian,You are certainly not the first to call on everyone to avoid belief systems and ideology, focus on bipartisanship, post-partisanship, etc. We hear this all the time from mainstream publications. I find these calls to be well-intentioned but hopelessly misguided. The irony is that you appear to have a belief system of your own: a very strong belief in the status quo, particularly when it comes to the education system. You don't seem to notice it, however - probably because the vast majority of people agree with you.I apologize if this comes off as a bit harsh and personal. Again, a main point of mine is that it's not just you that holds these beliefs.
Ian,You are certainly not the first to call on everyone to avoid belief systems and ideology, focus on bipartisanship, post-partisanship, etc. We hear this all the time from mainstream publications. I find these calls to be well-intentioned but hopelessly misguided. The irony is that you appear to have a belief system of your own: a very strong belief in the status quo, particularly when it comes to the education system. You don't seem to notice it, however - probably because the vast majority of people agree with you.I apologize if this comes off as a bit harsh and personal. Again, a main point of mine is that it's not just you that holds these beliefs.
Despite valid points on both sides, neither is addressing a fundamental need for a cohesive economic strategy to get us out of the mess we are in. I think everyone should read Michael Porter's article in the November 10th Business Week: "Why America Needs an Economic Strategy"
#...In the article, Porter outlines several key areas that have made the US the most competitive (and economically strong) country in the world:1. An unparalleled environment for entrepreneurship and starting new companies.
2. Science, Technology and innovation have fed US growth and economic development
3. Some of the best higher education institutions in the world.
4. Strong commitment and culture of competition and free markets (my note: irrespective of which school of economics pleases you)
5. Highly decentralized and regional economic advantages based on specialized regional strengths like movie industry in Hollywood, Life Sciences in Boston.
6. Deepest and most efficient capital markets and risk capital.
7. Inherent dynamism and resilienceDespite these endowments however, the US is failing on many counts. eg. The US ranks 12th in % of college grads, behind Denmark and only one rank ahead of Spain. A lack of strategy is causing over-regulation in some areas and under-regulation in other areas and is undermining America's competitive advantage.I agree with Krish's point that we cannot run the country based on belief systems. There are alot of smart people in the room; its time to forge an action plan based on strategy not ideology or partisanship.
Despite valid points on both sides, neither is addressing a fundamental need for a cohesive economic strategy to get us out of the mess we are in. I think everyone should read Michael Porter's article in the November 10th Business Week: "Why America Needs an Economic Strategy"
#...In the article, Porter outlines several key areas that have made the US the most competitive (and economically strong) country in the world:1. An unparalleled environment for entrepreneurship and starting new companies.
2. Science, Technology and innovation have fed US growth and economic development
3. Some of the best higher education institutions in the world.
4. Strong commitment and culture of competition and free markets (my note: irrespective of which school of economics pleases you)
5. Highly decentralized and regional economic advantages based on specialized regional strengths like movie industry in Hollywood, Life Sciences in Boston.
6. Deepest and most efficient capital markets and risk capital.
7. Inherent dynamism and resilienceDespite these endowments however, the US is failing on many counts. eg. The US ranks 12th in % of college grads, behind Denmark and only one rank ahead of Spain. A lack of strategy is causing over-regulation in some areas and under-regulation in other areas and is undermining America's competitive advantage.I agree with Krish's point that we cannot run the country based on belief systems. There are alot of smart people in the room; its time to forge an action plan based on strategy not ideology or partisanship.
Oops. Spelling mistake. It should be *I still haven’t come across a single argument that shows clearly how unregulated system can go without creating a mess like this*
Oops. Spelling mistake. It should be *I still haven’t come across a single argument that shows clearly how unregulated system can go without creating a mess like this*
Sridhar,Lemme state clearly. I didn't say fed is the reason for the problem. I meant that certain actions by the feds accelerated the issue. I do agree with Libertarians that we need to clean up the feds. No second opinion on that. We need to streamline them and make them efficient. However, my argument is that the deregulation is not the alternative option. Feds can regulate smartly without doing some of their past mistakes.I do agree with you that UK and other countries, who are ideologically different from the Libertarian view point, are in the same mess. However, this is not an argument I was looking for. Saying that their approach also didn't work is not a solid argument in favor of deregulation. I am looking for something more solid. I still haven't come across a single argument that shows clearly how unregulated system cannot go without creating a mess like this.In my opinion, we cannot run the country based on belief systems, whether it is the role of god or the role of god like markets. We need to see what is presented to us and take smarter actions. Sometimes it may mean deregulation and sometimes it may mean stricter regulations. We cannot use one size fits all approach here.Anyhow, I love debates like this and I am glad people are debating in a civil manner. Keep it coming :-)
Sridhar,Lemme state clearly. I didn't say fed is the reason for the problem. I meant that certain actions by the feds accelerated the issue. I do agree with Libertarians that we need to clean up the feds. No second opinion on that. We need to streamline them and make them efficient. However, my argument is that the deregulation is not the alternative option. Feds can regulate smartly without doing some of their past mistakes.I do agree with you that UK and other countries, who are ideologically different from the Libertarian view point, are in the same mess. However, this is not an argument I was looking for. Saying that their approach also didn't work is not a solid argument in favor of deregulation. I am looking for something more solid. I still haven't come across a single argument that shows clearly how unregulated system cannot go without creating a mess like this.In my opinion, we cannot run the country based on belief systems, whether it is the role of god or the role of god like markets. We need to see what is presented to us and take smarter actions. Sometimes it may mean deregulation and sometimes it may mean stricter regulations. We cannot use one size fits all approach here.Anyhow, I love debates like this and I am glad people are debating in a civil manner. Keep it coming :-)
Thanks for using your platform to promote the voice of reason. I fear we're in for a head-first dive into a government-run economy. People from all over the world come here for our economic freedoms and opportunities. Where will we go?
Thanks for using your platform to promote the voice of reason. I fear we're in for a head-first dive into a government-run economy. People from all over the world come here for our economic freedoms and opportunities. Where will we go?
ern, interventionists, particularly Krugman, have to make this deregulation-caused-the-crisis argument, because, as I have pointed out, Krugman was arguing for continued low interest rates as late as fall of 2004, even as housing was clearly bubbling up, even as Greenspan had started his baby-step tightening. At that time, his policy made Greenspan look very courageous, tightening even as interventionists were arguing to keep interest rates low. Interventionists cannot embrace the credit boom hypothesis, because so many of them were cheering on the credit boom.In Krugman's case at least, as a true in-the-long-run-we-are-all-dead Keynesian, his economic horizon does not extend so far as to connect Fed policies in the post-Nasdaq bubble work out period (which he fully supported) with the present crisis. Their mathematical models don't have so much history built in either :)
ern, interventionists, particularly Krugman, have to make this deregulation-caused-the-crisis argument, because, as I have pointed out, Krugman was arguing for continued low interest rates as late as fall of 2004, even as housing was clearly bubbling up, even as Greenspan had started his baby-step tightening. At that time, his policy made Greenspan look very courageous, tightening even as interventionists were arguing to keep interest rates low. Interventionists cannot embrace the credit boom hypothesis, because so many of them were cheering on the credit boom.In Krugman's case at least, as a true in-the-long-run-we-are-all-dead Keynesian, his economic horizon does not extend so far as to connect Fed policies in the post-Nasdaq bubble work out period (which he fully supported) with the present crisis. Their mathematical models don't have so much history built in either :)
Sekar, I agree with you. I set a simple goal to judge “successâ€, because even that is going to be hard given the magnitude of what the world faces.I will make a later post on the moral implications (rising inequality) of what happened. The interventionists, Professor Krugman in particular, have argued that it was their political opponents (not libertarians, because those are marginalized anyway, but the Republicans in power) that actively aided and abetted inequality. Inequality also rose pretty strongly in the UK, but the American interventionists would not want to look there.
Sekar, I agree with you. I set a simple goal to judge “successâ€, because even that is going to be hard given the magnitude of what the world faces.I will make a later post on the moral implications (rising inequality) of what happened. The interventionists, Professor Krugman in particular, have argued that it was their political opponents (not libertarians, because those are marginalized anyway, but the Republicans in power) that actively aided and abetted inequality. Inequality also rose pretty strongly in the UK, but the American interventionists would not want to look there.
The idea that deregulation caused this mess is strange. Financial markets are one of the most heavily regulated sectors of the economy, even after the deregulation we've seen. Had government not intervened in the market to advocate purely political goals (increased homeownership, for example) the conditions for this bubble would not have existed. This crisis was caused by interventionism by government, not a fault of the market.That's not to say there isn't an argument for some interventionism by government. But there is good intervention and bad intervention. Government might need to "facilitate" markets, but it should do so primarily by getting out of the way. Clearing obstacles to natural market corrections rather than forcing corrections (and more often than not, overcorrecting). Government intervention almost always creates perverse incentives that the market is unable to correct without a rough landing. Basically, when government intervenes, the market has to work harder to reach equilibrium. The massive intervention we're seeing now is going to hurt. The only question is when the bill comes due, and who is going to have to pay it.
The idea that deregulation caused this mess is strange. Financial markets are one of the most heavily regulated sectors of the economy, even after the deregulation we've seen. Had government not intervened in the market to advocate purely political goals (increased homeownership, for example) the conditions for this bubble would not have existed. This crisis was caused by interventionism by government, not a fault of the market.That's not to say there isn't an argument for some interventionism by government. But there is good intervention and bad intervention. Government might need to "facilitate" markets, but it should do so primarily by getting out of the way. Clearing obstacles to natural market corrections rather than forcing corrections (and more often than not, overcorrecting). Government intervention almost always creates perverse incentives that the market is unable to correct without a rough landing. Basically, when government intervenes, the market has to work harder to reach equilibrium. The massive intervention we're seeing now is going to hurt. The only question is when the bill comes due, and who is going to have to pay it.
Krish, look at your own argument: you are saying Fed is responsible for the mess, and Fannie & Freddie (Government sponsored enterprises!) acted as accelerators. Show me a libertarian who would ever support the existence of Fannie & Freddie, leave alone the Fed itself.If your argument is that Fannie and Freddie were poorly regulated, well, it turns out the political blame for that is not so neatly assigned to the free market ideologues.Finally, look at the UK to see a similar (perhaps even bigger!) crisis as the US, yet a very different ideological dispensation. No one accused the Labour party of an excess of deregulatory zeal, I assume.That UK example should serve to illustrate the main libertarian argument: the foundation of the economic boom of the last several years was unsound, and was driven by a credit boom. Various different governments around the world of a variety of different political persuasions aided and abetted it in various ways, but at is root, it was a credit boom, driven by a totally misguided monetary policy. You can always find proximate villains (such and such Senator lobbying for Fannie in 2004 - usually on the left - or arguing for a hands-off policy on derivatives in 2005 - usually on the right - etc) but those are only supporting cast in the main drama.
Krish, look at your own argument: you are saying Fed is responsible for the mess, and Fannie & Freddie (Government sponsored enterprises!) acted as accelerators. Show me a libertarian who would ever support the existence of Fannie & Freddie, leave alone the Fed itself.If your argument is that Fannie and Freddie were poorly regulated, well, it turns out the political blame for that is not so neatly assigned to the free market ideologues.Finally, look at the UK to see a similar (perhaps even bigger!) crisis as the US, yet a very different ideological dispensation. No one accused the Labour party of an excess of deregulatory zeal, I assume.That UK example should serve to illustrate the main libertarian argument: the foundation of the economic boom of the last several years was unsound, and was driven by a credit boom. Various different governments around the world of a variety of different political persuasions aided and abetted it in various ways, but at is root, it was a credit boom, driven by a totally misguided monetary policy. You can always find proximate villains (such and such Senator lobbying for Fannie in 2004 - usually on the left - or arguing for a hands-off policy on derivatives in 2005 - usually on the right - etc) but those are only supporting cast in the main drama.
I'd like to reserve the import of the top-down strategies until certain baseline factors are resolved; a) the National Debt, and b) Spending.I know there's and interweve to some extent, but it makes sense that an objective assessment of strategies cannot be promulgated until the aforementioned factors are, if not resolved (which is /highly/ unlikely ), at least brought to the front burner on Medium.btw, Within the pros and cons of your dichotomy there seems to be no mention of laziness and greed. The agnosticism of such vice serves well to highlight their probable culpability.Great article. Thanks.
I'd like to reserve the import of the top-down strategies until certain baseline factors are resolved; a) the National Debt, and b) Spending.I know there's and interweve to some extent, but it makes sense that an objective assessment of strategies cannot be promulgated until the aforementioned factors are, if not resolved (which is /highly/ unlikely ), at least brought to the front burner on Medium.btw, Within the pros and cons of your dichotomy there seems to be no mention of laziness and greed. The agnosticism of such vice serves well to highlight their probable culpability.Great article. Thanks.
I am afraid, leaving it without interventions won't cure it but it's like letting it die. And a few such deaths will have a cascading effect globally. I believe intervention is the best medicine for the moment.
I am afraid, leaving it without interventions won't cure it but it's like letting it die. And a few such deaths will have a cascading effect globally. I believe intervention is the best medicine for the moment.
I am not a libertarian by a mile, but the interventionist approach didn't work in Japan. The economy has continued to stagnate for decades, but job losses are minimal. That's the route the US is going down right now, seems like.
I am not a libertarian by a mile, but the interventionist approach didn't work in Japan. The economy has continued to stagnate for decades, but job losses are minimal. That's the route the US is going down right now, seems like.
Regulation makes it possible for a modern economy to work. We can debate over how much regulation is needed, but in the end, one of government's primary responsibility is to facilitate markets. They do this (or should do this) by creating a healthy environment for investors, banks, and business through regulation.
Regulation makes it possible for a modern economy to work. We can debate over how much regulation is needed, but in the end, one of government's primary responsibility is to facilitate markets. They do this (or should do this) by creating a healthy environment for investors, banks, and business through regulation.
Sridhar,I think you have fallen into the classic trap set by interventionists by judging their success with two simplistic outcomes - inflation and employment.Even if inflation comes down to 4% and unemployment is below 6% after 4 years you need to take into account what has happened in the last 20 years of credit boom and what is going to happen in between now and the next 4 years.. Is it OK if inflation is only 2% after all prices have gone up by 50%? That is food prices up by 50%, gas prices by 50%, housing prices up by 100% etc. Basically your post seems to suggest that the end justify the means.With the interventionists' approach the people who would be royally screwed are your average "Joe the plumber". His income would have increased by a modest 10% but the prices for almost all essential goods would have increased by 50%. The "Smart, well informed" people, who play the Wall Street game well, would have made sure their income increases by 100%. I am taking some random numbers to make my case. BTW, lots of the innocent bystanders like us would have benefited too because we at least partially participate in this game, although inadvertently.I believe this type of increase in inequality induced by the immoral interventionists is the root cause of the emergence of socialism and communism. And this is what it would lead to in the long run. Inequality per say is not the problem; that is the law of nature. The problem is that the average, innocent people have no clue that the money they are holding onto as savings will be worth a lot less in these years of boom and bust and that this is all caused by the misguided and unethical interventionists' policies of inflating the "fiat money". This would eventually play into the hands of the socialists and communists.So, de-regulation can be attributed as a cause of the current crisis only if you accept "fiat money" and the management of such money by a central bank as if it is a law of nature. But if you believe that the root cause of all this is the existence of fiat money and by extension the central bank managed fractional reserve banking system, then the question of regulation and de-regulation does not arise. Needless to say, by being the governor of Federal Reserve for more than 18 years, Alan Greenspan has no right to call himself a libertarian.Sekar Vembu
Sridhar,I think you have fallen into the classic trap set by interventionists by judging their success with two simplistic outcomes - inflation and employment.Even if inflation comes down to 4% and unemployment is below 6% after 4 years you need to take into account what has happened in the last 20 years of credit boom and what is going to happen in between now and the next 4 years.. Is it OK if inflation is only 2% after all prices have gone up by 50%? That is food prices up by 50%, gas prices by 50%, housing prices up by 100% etc. Basically your post seems to suggest that the end justify the means.With the interventionists' approach the people who would be royally screwed are your average "Joe the plumber". His income would have increased by a modest 10% but the prices for almost all essential goods would have increased by 50%. The "Smart, well informed" people, who play the Wall Street game well, would have made sure their income increases by 100%. I am taking some random numbers to make my case. BTW, lots of the innocent bystanders like us would have benefited too because we at least partially participate in this game, although inadvertently.I believe this type of increase in inequality induced by the immoral interventionists is the root cause of the emergence of socialism and communism. And this is what it would lead to in the long run. Inequality per say is not the problem; that is the law of nature. The problem is that the average, innocent people have no clue that the money they are holding onto as savings will be worth a lot less in these years of boom and bust and that this is all caused by the misguided and unethical interventionists' policies of inflating the "fiat money". This would eventually play into the hands of the socialists and communists.So, de-regulation can be attributed as a cause of the current crisis only if you accept "fiat money" and the management of such money by a central bank as if it is a law of nature. But if you believe that the root cause of all this is the existence of fiat money and by extension the central bank managed fractional reserve banking system, then the question of regulation and de-regulation does not arise. Needless to say, by being the governor of Federal Reserve for more than 18 years, Alan Greenspan has no right to call himself a libertarian.Sekar Vembu
I also want to clarify that when I say I am yet to see an article/paper that absolves deregulation from the current mess without starting with a god like belief system that "markets are powerful and they will take care of everything by itself". I want a more pragmatic argument without starting with any dogmas. I am yet to see one and hence I am suspicious of Libertarian arguments. If anyone can guide me towards any such existing article, it will be greatly appreciated.
I also want to clarify that when I say I am yet to see an article/paper that absolves deregulation from the current mess without starting with a god like belief system that "markets are powerful and they will take care of everything by itself". I want a more pragmatic argument without starting with any dogmas. I am yet to see one and hence I am suspicious of Libertarian arguments. If anyone can guide me towards any such existing article, it will be greatly appreciated.
Even though I agree with the fact that Federal Reserve is responsible for the mess, the bigger role is due to the hands off approach advocated by Libertarians. Now they are trying to spin out the mess saying "we told you so". I haven't come across a single valid argument that absolves the incessant deregulation from being a culprit for the current mess. If people can show me some article or research paper that clearly proves that the deregulation was not responsible for the current mess, I cannot buy the arguments of Libertarians. In my world view, I will keep deregulation as the main culprit and freddie and fannie kids as accelerators for the current crisis unless I see a valid argument that clearly establishes that the reason is otherwise.Sridhar, I strongly appreciate your bold approach of bringing in topics like this into the company blog. I am glad that you are not taking the time tested conservative route of not discussing politics in the company blogs. Keep up the good work.
Even though I agree with the fact that Federal Reserve is responsible for the mess, the bigger role is due to the hands off approach advocated by Libertarians. Now they are trying to spin out the mess saying "we told you so". I haven't come across a single valid argument that absolves the incessant deregulation from being a culprit for the current mess. If people can show me some article or research paper that clearly proves that the deregulation was not responsible for the current mess, I cannot buy the arguments of Libertarians. In my world view, I will keep deregulation as the main culprit and freddie and fannie kids as accelerators for the current crisis unless I see a valid argument that clearly establishes that the reason is otherwise.Sridhar, I strongly appreciate your bold approach of bringing in topics like this into the company blog. I am glad that you are not taking the time tested conservative route of not discussing politics in the company blogs. Keep up the good work.