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Fiscal and Monetary Stimulus is a net positive during recessions

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Austen Posted: Sun, Apr 15 2012 6:47 PM

I am currently in an online debate on the topic, "Fiscal and Monetary Stimulus is a net positive during recessions." Can you help me devise some rebuttals against my opponent's arguments?


This is his case:


Since WallStreetAtheist posted some arguments in his acceptance post, I feel compelled to respond to some of his "points."

"Please accept this as a better stated, full resolution: Resolved: Government fiscal and monetary stimulus is a positive response to economic downturns."

As we shall see later, the resolution is a bit vague for the sake of grabbing attention. Strictly speaking, there are certain recessions where fiscal and monetary stimulus would be counter-productive. Take for instance the recession between Carter and Reagan, or the "stagflationary" 70s. In such a situation, for reasons I shall expound upon later, fiscal and monetary stimuli would, rather than increasing output, create unexpected inflation, and all the attendant harms that such inflation causes. 

Now, despite what the crudely drawn cartoon of Ben Bernanke would have you believe, Quantitative easing is much more complicated than "giving banks dollars and hoping something good comes out of it." 

Now, on to my opening argument. I first want to explain the theory, or economic models, behind Fiscal and Monetary stimulus and then show some empirical evidence to test these models. 

Let's talk about one of the first principles of macroeconomics: The Quantity Theory of Money. The quantity theory of money can be expressed in the following equation: Quantity of Money x Velocity of money = Price x number of transactions (output). The quantity of money is just that, the amount of money that exists in a closed economy. Velocity is the amount of times that money changes hands, or how many transactions any given piece of money goes through. Prices are the nominal amount of money charged for a good or service, and the output is the number of end-user goods and services that are sold in a given closed economy. 

In classical and neoclassical economics (which almost every economist uses), output is fixed by the factors of production. At any one moment, there are only so many people who are willing to work, and there is only so much capital (which is all non-human factors of production) to augment their labor. This determines the amount of goods and services that an economy can produce. So, holding output fixed, an increase or decrease in the quantity or velocity of money will cause the price of goods to rise or fall. This tells us that a long-run policy of expansionary monetary policy will, all else equal, cause inflation in the long run. 
Keynesian economists, however, base their theory one one vital insight: long run conditions do not hold in the short run. In the long run, prices of goods sold will adjust to the quantity and velocity of money. However, in the short run, for various reasons including unionization, menu costs, long-term contracts, prices are not flexible. Rather, they are downwardly rigid or "sticky." 

In the short run, if the economy's demand for money increases or the quantity of money is reduced due to bank failure, the price of goods may not adjust quickly enough to accommodate for the reduced quantity and velocity of money. 

Recall my earlier exposition of the Quantity Theory of Money, or Q x V = P x O. If we hold the variable P(rices) constant, and we reduce the Q and/or V variables, the output of the nation's economy will be reduced, necessarily. 

This is why anti-government and explicitly anti-Keynesian, or anti-Krugman economists, like Thomas Sowell or Milton Friedman, grant that counter-cyclical measures during deflationary recessions reduce the severity of recessions. Friedman admitted as much here: , and Thomas Sowell stated as much explicitly on page 469 of "Basic Economics", 4th ed. 

Now that we have a rough idea of the theory behind Keynesian economics (The actual theory is far more complicated, for a good introduction I would recommend N. Gregory Mankiw's excellent "Macroeconomics"), let's look at the data. Keynesian economics predicts that, following periods of sharp deflation, there should be high unemployment. This is exactly what happened during the 1929-1933 recession. Austrian economists like Bob Murphy explicitly deny this fact. Murphy has stated that the federal reserve reduced interest rates and that its "tightwad policy" was not the cause of the depression. Murphy argues this much at length in chapter 3 of "The Politically Incorrect Guide to the Great Depression and the New Deal." What Murphy and many other Austrians conveniently ignore is that deflation was sharp and the monetary base contracted significantly during the '29-33 recession, and the Federal reserve in 1931 did raise the discount rate. While government policies of keeping wage rates high (Roosevelt and Hoover, moronically, thought that wages of industrial workers ought to be kept high so they could buy the output of the firms that they work for) no doubt had a negative impact, the increased spending by the federal government did not. 

Furthermore, Keynesian economics predicts that, in a demand-driven recovery, inflation should be high. While World War two, by itself, did not get the United states out of the private economy, as Robert Higgs excellently showed, this does not disprove Keynesian economics for, as he and Woods have pointed out, wartime price and wage controls turned the United States into a completely centrally-planned economy. However, if there was "pent up demand", as Thomas Woods mocked in his lecture "Keynesian economists vs. American History", then we should see that inflation skyrocketed before and as private output increased in 1946. Lo and Behold, this is exactly what we find when looking at GDP and inflation figures for the 1940s. As private output increased after the war, so too did inflation. 
There are times where fiscal and monetary stimulus would be counter-productive, such as in the stagflationary 70s. The reason for this is that the particular recession was caused by supply-side factors. Labor costs rose and the oil supply dropped due to an OPEC embargo, and for this reason the ability of the nation to produce goods was dropped. 

Recall the quantity theory of money. Q x V = P x O. In this case, supply side factors caused O to drop, and since Q and V were, for the most part, fixed, P had to rise. Since a nation's maximum output is fixed by its factors of production, an increase in Q or V would not have caused O to rise. However, when O is below its maximum, increasing Q or V can increase O. 

I myself have serious problems with Austrian economics right now, but I will save those criticisms for later posts. 

In conclusion, The proposition that Fiscal and Monetary stimuli are net positives during deflationary recessions is based on sound theoretical foundations, and comports strongly with empirical evidence, of which I only mustered a tiny portion. 




That is his case, can you help me find some points of contention with it or link me to some good articles deriding the fiscal and monetary stimulus he prescribes?

Thanks!

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First off, welcome to the forum!  Be sure to check the newbie thread for forum tips and how-tos.

Second, I want to point you to this piece by Tom Woods.

 

Next, it would be helpful if you were to check out the resources he cites, in particular The PIG to the Great Depression and the New Deal and the Keynesian Predictions vs. American History lecture.

First it needs to be recognized that much of his conjectures are non sequitur or correlation/causation fallacy.  (e.g. his whole section regarding Murphy and the GD.  It seems that he is asserting that just because high unemployment followed deflation, it was therefore caused by it.  Same thing when he says "if there was 'pent up demand' [...] we should see that inflation skyrocketed before and as private output increased in 1946.")  Next, for data on this, you might check chapter 5 of Meltdown, in which Tom Woods briefly discusses some of this data he relies on, such as GDP.

Further, for Keynesianism in general, there are so many resources on this there's virtually no debate to be had that hasn't been had before.  See here:

Critiques of Keynes: Here’s a List

Permanent Keynesian Refutation Thread

 

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Austen replied on Sun, Apr 15 2012 7:15 PM

Okay, thanks. 

Anyone is free to guide me...

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One thing I can tell you from years of experience is that anything you come up with will be rejected by Keynesians due to the fact that "empirical evidence" can be interpreted as fitting any theory.  So, I wouldn't waste time arguing with anyone with much investment in that view.  Whatever GDP growth is after a policy implementation, a Keynesian will always say that it would have been x% lower otherwise.  Example: If GDP rises 10%, they'll say it would have risen 11%+ had they been in charge.  If GDP falls 90% after, they will say that it would have fallen 91%+ if they had been in charge.  That is what it all comes down to.

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Caley McKibbin:
Example: If GDP rises 10%, they'll say it would have risen 11%+ had they been in charge.  If GDP falls 90% after, they will say that it would have fallen 91%+ if they had been in charge.

And then when they are in charge and it still doesn't work out that way, it becomes "We didn't do enough of x.  If we had done more, we would have gotten the result we predicted.  But still, if it weren't for us, it would be much worse."

 

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Oops.  I meant 89% instead of 91%.

 

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Austen replied on Mon, Apr 16 2012 11:32 PM

Can anybody help me with this?

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John James replied on Mon, Apr 16 2012 11:54 PM

wallstreetatheist:
Can anybody help me with this?

Seriously?

We did help you.

a) His argument is basically non sequitur or correlation/causation fallacy

b) Check out the sources I recommended and you'll get a better understanding (i.e. explanations) of why he's wrong and what he's overlooking.

c) As Tom Woods said: "In the time it takes to carry on a Facebook debate, you could be reading. You could be making yourself a formidable debater one or two years from now. Instead of asking me to hand you a fish, you can be learning to fish."

I could have just left you with "c" and been done with it.  But I gave you "a" and "b" as well.  And you're still not satisfied?  Did you honestly come here looking for someone to just make your argument for you so you could copy and paste it into your debate?

 

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Austen replied on Tue, Apr 17 2012 12:04 AM

I would rather have had a referral to some literature that deals with fiscal and monetary stimulus with which I could write my own debate kritik. Thank you for your time.

I've listened to lectures here for a few months, but most of the economic downturn stuff I've heard has dealth with the depression of 1920-21, the great depression, and various aspects of liberty and the state.

Once again, thanks for your time.

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