Moses: It is not the business of a Ruler to be truthful, but to be politick: he must fly even from Virtue herself, if she sit in a different Quarter from Expedience. It is his Duty to sacrifice the Best, which is impossible to a little Good, which is close at hand.
Mr. Loke: If men were told the Truth, might not they believe in it? If the Opportunity of Virtue and Wisdom is never to be offer’d ‘em how can we be sure that they would not be willing to take it? Let Rulers be bold and honest, and it is possible that the Folly of their Peoples will disappear.
From "A Dialogue ‘appearantely in the writing of Voltaire,’ published ‘for the first time’ in Lytton Strachey’s Books and Characters (1922) As quoted by Robert Skidelsky in John Maynard Kenyes: 1883-1946 Economist, Philosopher, Statesman
Paul Krugman writes a post he labels as "slightly wonky." Well, very slightly, it’s a first year macro-level wonky, and that’s good. Complex explanations in economics should be suspect. In it, he argues that the Fed has followed a simple inflation based rule for setting interest rates; that fed interest rates have moved with the budget deficit, which means a correlation between monetary and fiscal stimulus; and therefore it is investment demand that drives all of this. He tells the conservatives to go pound sand in their theory that the present slump is from a sudden outbreak of laziness. So far, so good. Except, there’s a hole. That hole is that the Fed hasn’t followed the simple "Taylor rule." In fact, there’s been a significant gap between Taylor rule and interest rates. Or more exactly, two of them.
The first was between 1994 and 1998 — the Fed was consistently above the Taylor rule. This lead several more left-leaning economists to call for lower interest rates to get more growth. The second was between 2001 and 2008 – the Fed was consistently below the Taylor rule. What a coincidence. So the argument that the Fed was a transparent carrier of the economic demand for funds breaks down. The other point is that there is a simple explanation for all three – short term rates, inflation, and budget deficits moving in tandem over the last 10 years, namely that they represent the same thing, not a market that is clearing, but three different forms of the same thing, namely, risk aversion. Risk aversion would lead to lower private investment, thus increasing the funds available for budget deficits. Risk aversion would lead to lower demand, and therefore lower inflation. And risk aversion would be a reason for the Fed to lower interest rates dramatically, as it did in late 1997 to deal with the Asian financial crisis.
The reality is that Federal Reserve interest rates, government bond auctions, and federal budget deficits all have one thing in common: they aren’t markets in the sense of "many independent actors making independent decisions." The Fed’s decision is in the hands of a few people, most of the buyers of government treasuries is a small number of large players, and of course, the Federal budget deficit is written by a few hundred people and their staff members. These are not large markets, but small ones. Hillary was pilloried for saying that it takes a village to raise a child; but the evidence here -given that the results of the last 10 years have been a market crash, a terrible recovery, and a massive global downturn- is that it took "The Village" to raze the economy.
So the picture that Dr. Krugman paints is not quite correct: it is true that animal spirits of demand are driving the rise and fall of business; but it is the Keynesian insight, that fear of the dark uncertain future – a fear that someone in the first half of the 20th century would see more keenly than our age of complacency fed leaders can – is as important a driver. The implication is that if the animal spirits of a small core of people can wreck the economy, then it is time to return to the crucial modern liberal insight: that government must act as a counterweight to the herd instincts of fear at the top.
But that is easy to say, it is harder to put forth solutions, and build political coalitions. The anti-Keynesian moment is gripping Washington – in no small part because there is an excellent living to be made being a venom-spewing right-wing hack, while many Keynesian economists are pushed out deliberately. For example with today’s statements that the public option is dead, officially not essential; it’s so good of people with health-care-for-life to decide that others must bear the risk of disease.
One book that is coming out soon that will repay attention to this will be Prof. Paul Davidson’s The Keynes Solution. Keynes insights into the macro effects of synchronization only lately have had the mathematical language to describe them. This synchronization of concentration of decision in the hands, or more accurately, in the guts of a few alters the fundamental dynamics of markets, and turns what should be supply and demand markets into vast vats of conformity.
The intent must be to break the sways of fear and greed that drive the very small cores of the investment culture, so that the macro-economy is again an economy. Dr. Krugman stares in the face the Greenspanian bending of the rules for a political ideology: deficit hawk for the Democrats, deficit dove for the Bushians. He rightly dismisses the New Classical attempt to blame the poor for not wanting to work hard enough; but does not as directly as John Maynard Keynes would, identify the rapacious greed of a few and their ability to profit from fear that they, themselves, create. After all, when looking back at the last decade, other than 9/11 -which was a crisis in truth so small that we still have not bothered to capture bin Laden- all of the drivers of risk aversion were created by the very people setting deficits and interest rates: Bush and his team were the source of the risk that they were selling insurance against. It is only when the spirits that were let of out of the box took on a life of their own that the edifice came crashing down.
The data that Dr. Krugman presents tell a very simple story: that of an era which created risk, and then used that as a driver to both lower rates on themselves, and engage in fiscal looting to profit themselves; confident that since they were the source of the risk, they could manage it. This is strategy money in a nutshell: the dollar is not based on the good we do, but the evil we threaten. America is too big too fail, and the better at creating "Shock Doctrine Risk" its leaders are, the more these leaders can spend. In effect low interest rates created a devaluation tax, particularly on developing economies.
But there’s a lesson from the New Classicals which they don’t heed; but which is staring back in their own mathematics: namely, it is a Ricardan Equivalence that can only hold as long as we have a credible threat to tax. That day is running out. Having given us the tools to understand the crisis, the paradigm of Keynes needs also to be the source of solutions to it. Our leaders are ignoring that, and it is at our peril.