YOU DECIDE: Which ‘ism’ should guide economic policies?

Date posted: May 27, 2011

Dr. Michael Walden is William Neal Reynolds professor of agricultural and resource economics at N.C. State University.Dr. Michael Walden is William Neal Reynolds professor of agricultural and resource economics at N.C. State University.

Media Contact: Dr. Mike Walden, 919.515.4671 or michael_walden@ncsu.edu

You Decide: What ‘ism’ should guide economic policies?

By Dr. Mike Walden
North Carolina Cooperative Extension

In many ways it’s a great time to be an economic educator. Almost everyone’s interested in the economy. People are always approaching me — in the supermarket, the gym and restaurants — and asking my opinion of what should be done to make the economy better. I’m flattered!

At the same time, there’s intense disagreement about the best economic policies. Conflicting policy prescriptions are often offered by different groups.

I won’t solve these disagreements here. Instead, I’ll review the economic philosophies behind the alternatives — along with their pros and cons — and let you decide which makes the most sense.

There are three major competing ideas about how to handle today’s economy: Keynesianism, monetarism and libertarianism. Let me review the high points of each.

Keynesianism, named after the 20th century English economist John Maynard Keynes, has been the most dominant in the last 80 years. Keynes’ idea was to use government to lean against the direction of the economy. That is, when the economy is growing rapidly and inflation is a threat, government would raise taxes and reduce spending to cool off growth. And when the economy is in reverse — that is, we’re in a recession — lower taxes and more government spending is the cure.

We can see Keynesianism at work in the last three years in fighting the recession. Tax cuts and additional federal spending (the TARP and stimulus plan) totaling almost $2 trillion have been used to counter the downturn in private spending.

However, critics level two primary complaints against such Keynesian policies. First, they question their effectiveness. Critics contend that funds collected and spent by the government always have alternative uses, and therefore, any economic activity created by such spending is simply a substitute for other spending and jobs that would have been created elsewhere.

Second, they point out that both parts of the Keynesian program usually aren’t used. While spending increases and tax cuts are popular, the opposite — spending decreases and tax hikes — are harder to pass. Therefore, spending and debt incurred by the government tend to rise over time.

The main contender to Keynesianism is monetarism, whose central premise is that money matters to the direction of the economy. In most modern economies, the country’s central bank — the Federal Reserve in the U.S. — has substantial control over the amount of money in circulation. Supporters of active monetarism say in times of recession, the Federal Reserve should pump up the money supply to encourage lending and spending. If the economy is over-heating, it should do the opposite.

Recently our Federal Reserve has followed the anti-recession prescription to the letter. Since 2008, it has added almost $1.5 trillion to the nation’s money supply. Supporters of the Fed’s actions say only it prevented a total collapse of the economy and financial system.

But not everyone is sold on this strategy. Simple logic suggests a potential problem; if money is printed at a rate faster than the products and services on which money is spent, then prices will rise faster. In other words, we’ll get higher inflation. Fed critics say we’re reaping this unwanted result today.

Libertarianism is both a political and economic philosophy, but I’ll focus only on the economic aspects here. Essentially, libertarianism rejects both Keynesianism and monetarism as ways to cure the economy, especially during recessions. At best, libertarians say, Keynesianism and monetarism can only give short-run benefits to the economy, “sugar highs” as some might call it. But eventually the high will run its course and the bitter after-taste of higher debt, higher taxes and higher inflation will take hold.

Libertarians offer policies to promote long-run economic growth, such as balanced budgets, simple taxes and fewer regulations.

But libertarians have their share of opponents. Some say that before Keynesian and monetary policies were used, the economy was marked by horrible recessions that lasted years. Yes, the economy would eventually recover in the long run, but the long run could be a very long time. Indeed, Keynes famously said, “In the long run, we are all dead.”

So the gloves are off and the bell has rung in the great economic policy match. You decide who will — and should — come out the champion!

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Dr. Mike Walden is a William Neal Reynolds Professor and North Carolina Cooperative Extension economist in the Department of Agricultural and Resource Economics of N.C. State University’s College of Agriculture and Life Sciences. He teaches and writes on personal finance, economic outlook and public policy. The College of Agriculture and Life Sciences communications unit provides his You Decide column every two weeks. Previous columns are available at http://www.cals.ncsu.edu/agcomm/news-center/tag/you-decide

Related audio files are at http://www.cals.ncsu.edu/agcomm/news-center/category/economic-perspective/

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