The Obama administration is at a fiscal crossroads. Should it pass another stimulus to avoid a damaging slump? Or should it follow Europe’s lead and begin to cut spending to bring long-term debt under control before it drags down the economy?
The choice it makes could have profound consequences on everything from the job market to the value of stocks, mortgage rates, and the price of milk.
The president has no shortage of economic advisers on his payroll. But one other source to which he could turn for counsel is a pair of letters to the editor that appeared in “The Times” of London – in 1932, when the Great Depression was in full swing but just before the New Deal.
Hayek was a leading figure in what became known as the Austrian school of economics. Its theory of the business cycle holds that recessions are primarily caused by government distortions of interest rates and the money supply that lead to imbalances in the supply side of the economy – imbalances that eventually require correction.
Keynes took a different approach. He argued that recessions involve a failure of “aggregate demand,” and that public (government) spending is needed to pick up the private slack.
Their letters concerned how Britain should respond to a worsening economy, but the underlying points they make also apply to the US economy, then and now. Indeed, the Great Depression is a good Rorschach test for your own convictions.
Do you think President Roosevelt’s New Deal was a crucial and ultimately effective tool that restored confidence and helped ward off the Great Depression? Then you’re probably a Keynesian.
Do you think FDR’s programs actually lengthened the economic slump because it distorted the market, crowded out private capital, and prevented correction? Then you’re probably a Hayek fan.
The second dip of the Great Depression – the downturn in 1937 – has particular relevance today. Keynesians say that the 1937 recession is a perfect example of the dangers of prematurely turning off the public spigot to balance the budget. Austrians point to other government policy mistakes – not fiscal discipline – as the culprit.
This intellectual contest predates the 1932 duel, of course. Governments have long used debt spending to try to quicken a sluggish economy. And in 1850, French economist Frederic Bastiat used a clever parable to make the case that most stimulus spending is foolish.
The fact that we’re still debating the merits of stimulus vs. austerity today is a reminder that economics remains as much a philosophy as a science. So when Obama – or any president – justifies a fiscal policy on the basis of “broad agreement” from “mainstream” economists, think back to those newspaper letters from 1932.